Applying Behavioural Finance – Season 3, Episode 7

Over the past six weeks, we’ve taken a look at what Behavioural Finance is, and spoken to some experts and practitioners for their thoughts on the subject. Today I want to look at applying behavioural finance in real-world situations, so that we all can stand the best chance of making optimum decisions.

Applying Behavioural Finance

This series has been really well received, and I’m grateful to everyone who has offered feedback. Certainly I’ve enjoyed delving deeper into this subject, which has fascinated me for a while. I know that it’s something I’ll keep coming back to.

I want to look at some true-life scenarios where you might have a need to apply what we’ve learned. Hopefully that way, when those situations come around, we can be prepared for them. Forewarned is forearmed and all that.

Here are the six scenarios I use to explain about applying behavioural finance

• What should I do with my portfolio in light of [Insert impending crisis here]?

• I’ve been checking my portfolio every day and it’s going down. I think I’m gonna sell.

• Oooo, that looks nice and shiny, should I spend/divert some of my savings, or pass?

• A friend gives me a stock/fund/sector tip; should I invest?

• My friend or family member has made big losses in their investments and has cashed everything in. Perhaps I should do the same?

• I want to invest but the market is high – should I wait?

These six scenarios, and doubtless many more, teach us about the five main biases of behavioural finance:

1. Over-reaction/availability bias – taking on too much news flow and reacting accordingly
2. Focusing on short-term performance – in the context of a long-term plan, what does it matter?
3. Following the herd – the wisdom of crowds is rarely visible in investing situations
4. Confirmation bias – being more aware of information that confirms  your pre-existing thoughts, and not being objective
5. Anchoring – latching onto artificial numbers and framing decisions in that context.

Resources mentioned in this week’s show

Self-check questions: Click the button below to download the checklist of questions to ask yourself when faced with a big decision:

Article: Real-world applications of behavioural finance – Nerdwallet

Video: Minds, Markets and Magic – Paul Craven

Podcast: Risk, Volatility & Timescale

For advisers (and anyone, really): Improving Investor Behaviour