Everything You Need To Know

• You are not a machine. Well, there may be some bots listening to this to scrape data for a large language model or something, but most of you listening to this are flesh-and-blood humans.
• We are a collection of biases and predispositions. Behavioural finance combines elements of psychology with traditional economics to understand how individuals make financial decisions.
  1. Limited Rationality: Unlike the traditional economic assumption that individuals always make rational decisions, behavioural finance recognises that people often have limited cognitive abilities and time constraints, leading to less than perfectly rational decision-making.
  2. Loss Aversion: People tend to feel the pain of losses more strongly than the pleasure of gains. This asymmetry can lead to risk-averse behaviour, causing individuals to avoid taking risks even when the potential rewards outweigh the potential losses.
  3. Overconfidence: Many individuals tend to overestimate their abilities and knowledge, leading them to take excessive risks or make overly optimistic predictions about the future. This overconfidence can lead to suboptimal investment decisions.
  4. Anchoring: People often rely too heavily on the first piece of information they receive when making decisions, even if that information is irrelevant or misleading. This anchoring bias can lead individuals to make decisions based on arbitrary reference points rather than considering all relevant information.
  5. Mental Accounting: Individuals tend to mentally compartmentalise their money into different categories, such as “spending money” versus “savings”. This can lead to irrational behaviour, such as being more willing to spend windfall gains than money earned through regular income.
  6. Herding: People often have a tendency to follow the actions of the crowd, assuming that the collective wisdom of others is superior to their own judgment. This herding behaviour can lead to market bubbles and crashes as investors buy or sell assets based on the actions of others rather than fundamental factors.
  7. Confirmation Bias: Individuals have a tendency to seek out information that confirms their existing beliefs or opinions while ignoring or discounting contradictory evidence. This bias can lead to the reinforcement of mistaken beliefs and the failure to consider alternative viewpoints.
  8. Regret Aversion: People often make decisions based on avoiding feelings of regret rather than maximising expected utility. This aversion to regret can lead individuals to make choices that are suboptimal in the long run, such as holding onto losing investments for too long out of fear of admitting a mistake.

Everything You Need To Do

• Accept your fallibility. We need to accept that as humans we are ill-equipped to make rational decisions, and we need to be hyper-aware of our tendency to be affected by these biases.
• Minimise loss-aversion by reframing. It's not for nothing that we say that when markets are down, shares are on sale. That's a reframing of what could otherwise be a painful experience.
• Be aware of how things are framed. All information, especially financial info, is presented to you in a way that suits the provider of that info. Two statements: This bond offers a 10% fixed return every year, or This bond will double investors' money every ten years. Maybe the doubling of the money sounds attractive, but if you get 10% compound return every year, you'll double your money much quicker than ten years.
• Use the wisdom of crowds, but choose your crowd. Online groups are great for sense-checking things – the Meaningful Money Facebook group is now nearly 17,000-strong. But no-one should seek advice there, only opinion.
• Remember, you’re not all that. Be very wary of overconfidence. That's partly why we recommend tracking markets – you have nothing to do with the outcome!
• Get help. Biggest part of an adviser's job is to coach our clients and challenge these biases where we find them. We often challenge clients, telling them they're full of it at times. We'll always do so gently, but we won't shy away from telling them the truth.

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