Psychology of investor behavior
This guide explores psychology from an advisor's perspective. The guide examines the causes of investor behavior and the biases that undermine sound investment decisions, offering concrete suggestions for addressing these biases.
behavioral finance
intuition and emotion play a major role in decision-making.
The origins of behavioral finance are rooted in cognitive psychology, which is the study of how people learn, what they know, and how they act on what they know.
As the field evolves, its focus has been and continues to on two related phenomena:
Why people, faced with investment and other financial decisions make the choices they do
How choices are, and can be, influenced
These interests are built on the four cornerstones of the field: an understanding of heuristics, prospect theory, and the concepts of framing and mental accounting.
Shortcuts to Choice
Amos Tversky and Daniel Kahneman, psychologists whose research laid the groundwork for behavioral economics, concluded after investigating decision-making in a variety of settings, that many people use heuristics, or mental shortcuts, to arrive at intuitive conclusions based on limitated and often unreliable information.
When these findings were published in 1973, they evoked outrage in some quarters—and accusations that Tversky and Kahneman were arrogantly condemning people for not thinking straight. But further study has confirmed not only the existence of mental shortcuts but also their impact on decision making.
a glimpse inside the brain
neuroscience provides key insights into how investors make financial decisions.
Many of the principles of behavioral finance are finding validation in neuroscience—the physiological study of the brain and nervous system. While human beings have speculated about the brain and consciousness for thousands of years, recent breakthroughs in brain imaging and other techniques provide insights into how the brain actually functions.
An emerging field called neuro-economics, which combines brain studies with psychological research and economic theory, is reshaping how many financial experts think about the way people make financial decisions.
Mind and Money
Many of the emotions, biases, and thought processes that contribute to financial decision-making have origins deep inside the brain and in the network of communications between different parts of the brain. Understanding something about these neural foundations can help advisors work with clients more effectively in making money management and investment decisions.