Keyword: behavioral finance and the role of psychology (MV 190, 34% KD)
As a financial professional, data is part of an everyday routine. Investment analyses, historical data, and trend reports—among other things—are important parts of the equation when helping a client lock in their next opportunity.
To add to a strong decision-making arsenal, we also recommend leveraging behavioral finance principles, or rather, the psychological factors that may impact a decision or market. The key question you should be asking yourself is this: how can I successfully balance hard data with behavioral insights to develop a more holistic picture for my client’s future?
Behavioral Finance and the Role of Psychology
Behavioral finance presents ideas that challenge traditional industry principles. This subset of behavioral economics takes into account ideas like:
- Investors may have limits to their self control
- Errors are possible, if not likely, from human mistakes
- Not all decisions are made rationally
- All individuals are subject to financial biases
The Efficient Market Hypothesis (EMH) directly opposes this mindset by stating that the stock market shifts in rational, predictable ways—but this doesn’t mean that either set of ideals is wrong. What if, instead, it’s important to consider that both may be true?
There are certain things within the financial industry that we can know with exactness—and the data will tell you just that. But that data may become more powerful when you couple it with supplementary insights on the psychological biases that could impact perceived certainty.
Four Common Financial Biases
There are roughly four categories which all forms of financial biases fall into:
- Confirmation bias: accepting information as true because it closely aligns with an individual’s currently held belief, regardless of flawed information.
- Loss aversion: placing more emphasis on loss within the market than growth opportunities.
- Familiarity bias: forming a positive opinion of an individual or organization based on familiarity over actual information.
- Experiential bias: believing an increased, and often inflated, probability of something occurring based on recently lived events.
Now, these principles aren’t new—in fact, they can be easily applied to areas far outside of our financial investments. For example, when was the last time you believed that your favorite sports team would win, even though the data said otherwise? That’s a bias, and you just might bet incorrectly because of it.
Each of these types of biases may cause someone to make an irrational decision—no matter what the hard data says. This is why it’s important for financial professionals to consider the behavioral insights that might impact their client’s perspective or the market they’re trying to operate within.
Balancing Data and Behavior Insights
Keep in mind, leveraging behavioral insights doesn’t mean that you throw the numbers out the window. Next time you start looking at the numbers, ask yourself questions like:
- Are there decisions that could impact my projections? What human biases might exist that could change this trajectory?
- What historical behavioral insights can help me predict what might happen with future market changes? Are there changes I need to make in order to prepare for that possibility?
- What kind of biases might I have as I examine this data? Am I analyzing this information correctly, or am I shifting the numbers to confirm a belief I currently have?
These types of questions can help add certainty to client recommendations because all biases and psychological factors are considered before taking action. They can also help financial professionals and clients identify why disconnects occur in their communication or decision-making—you’d be surprised what hidden biases need to be uncovered before moving forward.
Sharing Behavioral Insights with Clients
Behavioral insights are helpful when sharing a holistic vision with clients—but make sure that you rigorously examine their origin and context before sharing with a client. You can build credibility and more certainty as you leverage a suitable combination of behavioral finance principles and data analysis.
If you’re a financial professional that wants to apply these principles to practice, elevate your business or learn more about the Concorde team’s approach to helping our clients, please reach out to us directly through our website here.
This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Past performance and projections are not a guarantee of future results.
Securities offered through Concorde Investment Services, LLC, member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC, an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc.