How does behavioral finance work?

The concept shows us that when it comes to managing one’s own budget, people’s difficulties arise due to several factors, from poor buying habits to the herd effect.

For you to understand more about it, we prepared this article with relevant information about how behavioral finance works in detail. Good reading!

What is behavioral finance?

Behavioral finance is a way to assess whether all your financial decisions are made rationally. In general, they refer to the field of study dedicated to understanding the relationship between economics and psychology. The objective, in practice, is to understand what people consider when defining the management of their finances.

There is a very variable and discussed concept that aims to understand why, many times, we spend our money inappropriately. Obtaining logical explanations when dealing with a machine or a computer program is much simpler, but when it is something that involves emotions, the assessment must consider different aspects.

This explains, for example, the behavior of some people, who even though they are aware of the importance of organizing finances, also make decisions that are out of line with their goals. The practical life that considers the current moment of each one, the contexts of the situations and the impulse in the expenses, brought the need to expand the researches and to consider the knowledge of the area of ​​psychology on the human behavior.

How did they come about?

The study of behavioral finance involves the timing of decisions regarding money and what influences the spending decision. For this, it considers different factors such as the person’s life history, behavior patterns, beliefs, needs and individual experiences with money.

What is the purpose of this area of ​​study?

The pair of psychologists and researchers based their behavioral analyzes on risk involving finances. As a result, the Theory of Expected Utility was considered, which defended the evaluation of each of the possible results when acting rationally in the comparison of options, before making a financial decision.

Some economists believed, within this context, that people were often risk averse and chose what seemed the safest. However, the research identified a different fact that called attention. In a broad perspective, people tend to accept taking more risks in order to try to avoid losing their money.

The reason for this is that emotions related to fear of losing money directly affect the way study participants made their decisions. The tendency is for them to risk losing more in the confidence of the chance of avoiding a loss considered greater. From this, researchers created what became known as the “Prospect Theory”. Which defends financial behavior in a way that is not completely rational.

How does it works?

Behavioral finance decisions involve a number of factors. Among the main ones are primary emotions, beliefs built throughout life, behavior patterns and social influences. These types of influence are usually decisive. Even if the person cannot have an exact perception of it when organizing financial matters.

What are the standards?

Behavioral finance shows that our brains tend to place a lot of importance not only on criticism. But also on what we lose compared to what we gain. In view of this, the loss aversion that we mentioned earlier stands out as one of the main and most impactful behavioral patterns. An investor, for example, can choose to remain in a disadvantageous position since he has the prospect of improvement and this delays the possibility of assuming the loss of money.

Another pattern that needs to be considered is mental accounting. Which shows how people tend to be more irrational than basing their decisions on actual data. As a result, it is very common for us to do quick calculations in our heads instead of thinking about the impacts of certain expenses in a deeper way.

Herd behavior also directly influences behavioral finance. This is a trend that appears not only in finance, but in our lives in different aspects. As for the financial issue, this is reflected in buying promotions because everyone is indicating and then regretting the expense. Often, there is still the possibility of having an unrealistic view of a situation, such as, for example. When something is acquired with the aim of obtaining extra income. But at the end of the day the invested amount is not recovered.

What are the impacts of behavioral finance on decisions?

Knowing yourself in the face of patterns of behavior with money makes a difference when it comes to identifying errors and understanding exactly what triggers are involved in impulse purchases, for example. When a person sets out to set a financial goal on paper and doesn’t know where to start. Finding what the frequent mistakes are and solving them represents the first step to cultivating good attitudes in everyday life .

Everything involves the importance of knowing how you behave emotionally when it comes to money. By putting this method into practice. It becomes simpler to put the budget in front of a perspective that is not only more rational but also sees financial growth in different plans with a focus on always walking according to your possibilities.

What are the precautions to avoid falling into traps?

The big secret lies in keeping up to date with what is happening in the financial market and adapting decisions according to your reality. Each of these mental ambushes are embedded in common behaviors that can happen through impulses or habits.

A good tip for not falling into traps is to opt for detachment and understand that mistakes happen. From this, it is possible to achieve the objectives and create a plan aimed at organization and conscious consumption . This behavior can be considered a real game changer in understanding. What happens to your money.

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