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Behavioral Finance, also known as behavioral economics, uses experiments and research to demonstrate something that most of us already know: Humans aren't always rational, and the decisions we make are therefore sometimes flawed.  Behavioral finance goes even further, examining how difficult it can be to rid yourself of these ideas, even if you understand the issues at stake. The field of behavioral finance was developed partly in response to the efficient market hypothesis (EMH), a popular theory that states how the stock market moves in rational, predictable ways. Stocks typically trade at their fair price, and those prices are a reflection of available information that's available to everyone. You can't beat the market, in other words, because anything you know already has or soon will be reflected in market prices.

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Behavioral finance encompasses activities such as: spending, investing, trading, financial planning, portfolio management, and business commerce. In addition, behavioral implications are also challenging theories about how economies and financial markets function.

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You have to understand economic behavior and economic psychology to be able to understand behavioral economics. It uses psychology and economics to explore why people sometimes make emotional rather than logical decisions, and why their behavior does not follow the predictions of accepted economic models. It helps answer questions about why experienced investors buy too late and sell too soon, or why someone doesn’t use their savings account to help with paying off massive credit card debt.

 

It even studies anomalies such as the small but measurable advantage companies have in the market if their stock ticker abbreviations come first in the alphabet, or the effect of the weather on market values.

Behavioral economics has also identified that systematic errors and biases recur predictably in certain circumstances, offering a framework for understanding when and how people make mistakes. There are two types of human behavior that is said to factor heavily in behavioral economics: heuristics and biases.   Some of the biases are outlined on the American College website linked here.

 

Consumer decisions are usually driven by their emotions, so be careful when making decisions that you are thinking about the pros and cons of what the outcome might be.

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To find out more about behavioral finance watch this video:

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By: Jason Torrents