What is Behavioural Finance & How Does it Affect Your Financial Decisions?

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Across Europe, many households are feeling the pinch. With citizens worried about the cost of living, fuel shortages, and the ongoing Ukraine crisis, understandably, many people are taking a greater interest in their finances.

But how can an understanding of behavioural finance help you take back control?

What is behavioural finance?

Behavioural finance refers to the psychological study of investors and how their actions impact the financial markets. It’s about identifying and demonstrating that because humans don’t act rationally, neither do financial markets. Whilst we all like to think we’re rational beings, at times of stress our ability to think can become extremely flawed.

The myriad behavioural finance studies demonstrate that we all have subconscious biases that are impacting our financial decisions. And that once we identify and recognise these decision-making errors, we can make better, more rational financial decisions.

What are the behavioural finance biases?

Through the study of behavioural finance, academics have highlighted the most common biases:

  • Self-attribution bias: The belief that good outcomes are as a result of skill, whereas undesirable outcomes are as a result of bad luck.
  • Confirmation bias: Looking for evidence and information that supports your views or opinions, whilst ignoring evidence and information that refutes or contradicts it.
  • Representative bias: The belief that two events or things are more closely related, correlated, or inter-linked than they actually are. This often feeds into the confirmation and self-attribution bias’.
  • Framing bias: Depending on how an opportunity or proposition is presented will create either a positive or negative framing bias – regardless of what facts and figures suggest.
  • Anchoring bias: Being influenced by the first figure you encounter and basing all other judgements and reasoning on that first price or number.
  • Loss aversion: Trying harder to avoid a loss, than recognise a gain.

Ultimately all these unconscious biases control every area of our lives, not just behavioural finance. As pack animals were influenced by those around us and are driven by our desires and our emotions. We’re also affected by our ego and the belief that we think we know more than we do.

How to overcome behavioural finance bias

Whether you’re looking to overcome your financial biases to help with your decision making when it comes to Forex Trading, or you’re contemplating how to increase your pension pot, here are a few strategies you can try:

  • Put a plan in place before investing. Decide how much you are willing for a stock or share to increase or decrease before selling.
  • Because we’re more likely to react and remember a negative experience, instead of a good one, accentuate negative thinking around saving and investing. For example, ‘I’m saving money now, to avoid serious debt when I’m older’.
  • Make a note each time you make a financial decision. At the end of the year review your decisions. This will help pinpoint which biases are behind the majority of your financial decisions.

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