Personal Finance: Introduction to Behavioral Finance by @Phroogal
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Behavioral finance is a subcategory of finance that seeks to explain the rationality or irrationality of financial decision-making. It seeks to combine behavioral and cognitive psychology theory with finance to provide explanations for why people make irrational decisions.
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Personal Finance: Introduction to Behavioral Finance by @Phroogal
- 1. Jason Vitug @jasonvitug Introduction to Personal Finance Behavioral Finance Theory: Why We Make Irrational Financial Decisions
- 2. Introduction • The plan is to introduce behavioral finance theory. • The goal is for you to understand how our decision making is impacted by psychological behaviors. • The takeaway is to know important concepts and become more aware of our financial decision making process. www.phroogal.com @phroogal
- 3. What is Personal Finance? • Personal finance is the use of financial management principles with respect to individual or family unit finances to manage money, budget, save and spend while taking into account various future risks and life events. www.phroogal.com @phroogal
- 4. What is Behavioral Finance? • Behavioral finance is a subcategory of finance that seeks to explain the rationality or irrationality of financial decision-making. It seeks to combine behavioral and cognitive psychology theory with finance to provide explanations for why people make irrational decisions. www.phroogal.com @phroogal
- 5. Are you rational with money?
- 6. We’re NOT rational with money.
- 7. Irrationality with Money • We all want to be wealthy and increase our well-being. • We understand that we shouldn’t spend money we don’t have. But… • Emotion and psychology influence our financial behaviors in unpredictable and irrational ways. www.phroogal.com @phroogal
- 8. Behavioral Finance 1. Anchoring 2. Mental Accounting 3. Confirmation and Hindsight Bias 4. Gambler’s Fallacy 5. Herd Behavior 6. Over Confidence 7. Overreaction and Availability Bias 8. Prospect Theory www.phroogal.com @phroogal
- 9. Anchoring 1. Anchoring • Attaching our thoughts to reference points that have no logical relevance to decision at hand. – Diamond Engagement Ring – Stock Valuations www.phroogal.com @phroogal
- 10. Mental Accounting 2. Mental Accounting • A tendency to separate money based on subjective criteria often impacting financial decisions and wellbeing. – Saving for vacation or home earning very little interest yet continuing to pay high interest rates on existing debt. – Causes people to not use money efficiently such as “found money” www.phroogal.com @phroogal
- 11. Confirmation and Hindsight Bias 3. Confirmation Bias • Selectively filter and pay more attention to information that supports our opinion while ignoring any thing that may dispute it. 3. Hindsight Bias • Believing that the onset of past events were predictable and completely obvious although outcome could not be predicted. www.phroogal.com @phroogal
- 12. Gambler’s Fallacy 4. Gambler’s Fallacy • Belief that because of a series of events the likelihood of a random event will less likely occur. – Flipping a coin. www.phroogal.com @phroogal
- 13. Herd Behavior 5. Herd Behavior • Mimic the actions of a larger group whether rational or irrational. • Social pressure of conformity. – Taking out student loans. – General acceptance of credit cards – Purchasing a home. www.phroogal.com @phroogal
- 14. Overconfidence 6. Overconfidence • Confidence implies realistic trust in one’s ability while overconfidence usually implies optimistic assessment of one’s knowledge and control over a situation. www.phroogal.com @phroogal
- 15. Overreaction and Availability Bias 7. Overreaction and Availability Bias • We overreact to recent news and give more weight to recent trends. – Purchasing stocks because of recent good news causing price to skyrocket. Conversely, selling stock on bad news causing price to plummet. www.phroogal.com @phroogal
- 16. Pick One 1. You have $1,000 and must choose between A or B. --- Choose A) You have 50% chance of gaining $1,000, and a 50% chance of gaining $0. Choose B) You have a 100% chance of gaining $500.
- 17. Pick One 2. You have $2,000 and must choose between A or B. --- Choose A) You have 50% chance of losing$1,000, and a 50% chance of losing $0. Choose B) You have a 100% chance of losing$500.
- 18. Majority of people will choose (B) for Question #1 and choose (A) for Question #2. -------------- The right answers are either A or B for both questions. However, those choosing the answers above are more risk adverse.
- 19. Prospect Theory 8. Prospect Theory • Value gains and losses differently. Feel more pain in losing than joy felt in receiving equal amount of gain. • Given two equal choices, one expressed in gains and the other in losses, people choose the gains although yielding the same economic result. – Choosing not to save in a bank or refusing to work overtime. – Selling winning stocks and holding on to losing stocks. www.phroogal.com @phroogal
- 20. Is it okay to be irrational? • By understanding your mindset and behaviors, you can set up systems to account for the irrationality of our financial decision-making process. www.phroogal.com @phroogal
- 21. Learn more about at www.phroogal.com
Notas do Editor
- Importance of Mindset
- Importance of Mindset
- Importance of Mindset
- It’s about knowing where your money is going. It’s not that $4 will get you to a home but it’s an awareness. Saving a few extra dollars a month on coffee may not get you into a new home. However, the question should put some perspective on you spending habit. $4.00 x 5 days x 52 weeks = $1,040. In 5 years, that’s $5,200.
- It’s about knowing where your money is going. It’s not that $4 will get you to a home but it’s an awareness. Saving a few extra dollars a month on coffee may not get you into a new home. However, the question should put some perspective on you spending habit. $4.00 x 5 days x 52 weeks = $1,040. In 5 years, that’s $5,200.
- We overspend or don’t have a clear idea on what we’re spending on. Mindless spending is buying items that add no value or help you reach your goal. You continuously spend money on drinks and dinner out while dreaming of a trip to an exotic location.
- We overspend or don’t have a clear idea on what we’re spending on. Mindless spending is buying items that add no value or help you reach your goal. You continuously spend money on drinks and dinner out while dreaming of a trip to an exotic location.
- We can make decisions based on illogical reference points.
- Where the money comes from should not influence how it is spent. All money earned or found should be treated the same. Having savings is important but earning nothing from interest while paying off high rate loans is illogical.
- Confirmation Bias - An investor may choose to seek out information to confirm a belief rather than find sources that may contradict it. This thinking goes both ways in support or against a purchase or action. Hindsight Bias – is a need for our minds to make sense of chaos and place things in order.
- It's important to understand that in the case of independent events, the odds of any specific outcome happening on the next chance remains the same regardless of what preceded it.
- Common belief that a large group can’t be wrong. Even if you believe against it you might think you’re wrong because the large group may know something you don’t. Don’t jump into the latest trend without doing your own homework.
- People with access to the most up-to-date information can often struggle in making the best decisions.
- Retain a sense of perspective. It’s easy to get caught up in the news but short-term approaches don’t usually achieve best returns.
- People will settle for gains even though they’d have a reasonable chance of earning more. Losses are weighted more heavily than gains.
- People will settle for gains even though they’d have a reasonable chance of earning more. Losses are weighted more heavily than gains.
- People will settle for gains even though they’d have a reasonable chance of earning more. Losses are weighted more heavily than gains.
- The loss causes more pain than the joy experienced from an equal amount of gain.
- We overspend or don’t have a clear idea on what we’re spending on. Mindless spending is buying items that add no value or help you reach your goal. You continuously spend money on drinks and dinner out while dreaming of a trip to an exotic location.
- It’s about knowing where your money is going. It’s not that $4 will get you to a home but it’s an awareness. Saving a few extra dollars a month on coffee may not get you into a new home. However, the question should put some perspective on you spending habit. $4.00 x 5 days x 52 weeks = $1,040. In 5 years, that’s $5,200.