What are some theories that can be related to financial decisions? - continue reading to learn.
Behavioural finance theory is an important component of behavioural science that has been extensively researched in order to describe some of the thought processes behind monetary decision making. One interesting theory that can be applied to financial investment choices is hyperbolic discounting. This idea describes the propensity for individuals to prefer smaller sized, instant rewards over larger, postponed ones, even when the delayed rewards are significantly better. John C. Phelan would identify that many people are affected by these sorts of behavioural finance biases without even knowing it. In the context of investing, this bias can significantly undermine long-lasting financial successes, leading to under-saving and spontaneous spending routines, along with creating a top priority for speculative financial investments. Much of this is because of the gratification of reward that is instant and tangible, resulting in decisions that might not be as opportune in the long-term.
Research study into decision making and the behavioural biases in finance has led to some fascinating suppositions and philosophies for describing how people make financial choices. Herd behaviour is a popular theory, which describes the mental tendency that many individuals have, for following the decisions of a bigger group, most particularly in times of uncertainty or fear. With regards to making financial investment choices, this typically manifests in the pattern of people purchasing or selling possessions, simply because they are seeing others do the same thing. This kind of behaviour can fuel asset bubbles, whereby asset prices can increase, frequently beyond their intrinsic value, in addition to lead panic-driven sales when the markets change. Following a crowd can offer an incorrect sense of security, leading financiers to purchase market highs and sell at lows, which is a rather unsustainable financial strategy.
The importance of behavioural finance depends on its capability to discuss both the rational and illogical thought behind different financial processes. The availability heuristic is an idea which explains the psychological shortcut through which individuals evaluate the probability or significance of events, based on how quickly examples enter mind. In investing, this typically results in decisions which are driven by recent news events or stories that are mentally driven, rather than by considering a broader interpretation of the subject or looking at historic information. In real life contexts, this can lead investors to overestimate the possibility of an . event occurring and develop either a false sense of opportunity or an unnecessary panic. This heuristic can distort understanding by making rare or severe events appear far more typical than they actually are. Vladimir Stolyarenko would know that in order to combat this, financiers must take a deliberate method in decision making. Likewise, Mark V. Williams would know that by using information and long-lasting trends financiers can rationalize their judgements for much better results.