Behavioral finance is a field of study that explores how psychological factors influence the decisions and behaviors of investors. It can help you understand the needs, preferences, and biases of your clients, and provide better advice and service. In this article, you will learn how to use behavioral finance to understand investor needs in four steps.
Identifying common biases that affect investors is the first step to helping them make rational and objective decisions. These biases include overconfidence, which is the tendency to overestimate one's own abilities and knowledge, as well as underestimate risks and uncertainties. Loss aversion is another bias that causes people to prefer avoiding losses over acquiring gains, and to react more strongly to losses than to gains. Confirmation bias is the tendency to seek and interpret information that confirms one's existing beliefs, while ignoring or discounting information that contradicts them. Lastly, the framing effect is when people are influenced by the way information is presented, rather than by its objective content. Recognizing these biases can help clients avoid making irrational or emotional decisions.
In my research, behavioral finance appears to have developed almost as an apology for the explanatory failures of classical economics-inspired finance—instead of being a jumping off point for critiquing and improving financial theory. We are not lab rats—we are humans trying to do the best we can to satisfy a complex of needs with limited resources, time and information.
Certified Financial Planner, Financial Wellness Practitioner, Macro Analyst
I don't believe in behavioral finance the way American academics use it. It's a deeply incorrect "science" the way it is presented here. Risk tolerance is something that can be learned and expanded on, loss avoidance can be managed and so on. You have to understand a person's money narrative to make any headway - that takes a lot less science and a lot more therapy - which most advisors do not practice because it takes time and most advisors are incentivized by & chasing AUM. Once you understand a person's money narrative you can start to help them overcome bad habits or inadequate thinking around money and investments. Without it, all the "behavioral" science in the world is worth very little. Your clients are humans, not lab rats.
Behavioural science is not a science, the term is an oxymoron. Investing behaviour is extremely and deeply personal at individual level. Hence, it has to be understood in the context of an individual’s unique circumstances, risk tolerance, time horizon, financial needs, emotional stability, and so on.
Behavioral finance combines insights from psychology and economics to understand how individuals make financial decisions. By integrating these strategies, financial professionals can create a more nuanced understanding of individual investors, fostering personalized and effective investment approaches that align with both financial goals and behavioral tendencies. Applying behavioral finance principles can help financial professionals better understand investor needs.
There's a lot of great behavioural finance out there - I wrote a book about it. The key is to look at it from a variety of different disciplines, not only through the lens and assumptions of classical finance/economics theories. For example, there's a lot of crossover theory between biopolitics, exercise physiology and behavioural finance approaches, even meteorology. But the fields rarely combine. It's a classic systems theory approach, which also brings in different philosophical assumptions which then leads to genuinely exciting, insightful observation.
The second step is to assess the risk tolerance of your clients, which is the degree of uncertainty and volatility they are willing to accept in their investments. Factors that influence risk tolerance include personality, goals, experience, and emotions. For instance, some people may be more adventurous and optimistic, while others may be more cautious and pessimistic. Furthermore, some people may have more specific and time-bound goals, while others may have more vague and flexible goals. Additionally, some people may have more exposure and familiarity with different types of investments, while others may have less or none. Lastly, some people may be more prone to fear and anxiety, while others may be more resilient and confident. By understanding the risk tolerance of your clients, you can help them choose the appropriate level of risk and return for their investments, as well as manage their expectations and emotions.
Risk assessment is good when its 10% loss and 25% profit .so that way example :10 scrips or portfolios would give a profit. 1)4 scrips in profits is- 100% profit ,6 in loss is -60% loss we still in profits with 40% 2)say worst case scenario 2 scrips profit-50% ,8 scrips is -80% we are in 30% loss. 3) 3 scrips profit -75% ,7 scrips -70% loss so we are in 5% profit. with this on an average we need to have minimum 3 best scrips to cover up all the losses. so there is no room for fear and anxiety.
Behavioural psychology studies actual investor behaviour, rather than theorising about it. It identifies behavioural biases that may influence an investor’s risk tolerance and risk appetite and can be used to improve the risk profiling process. It is a broader view than the finance sub-field. Positive psychology concentrates on the positive aspects of human experience, such as happiness, and well-being. Although it is not commonly integrated into risk profiling, advisers can use it to better understand their client’s needs and preferences, thereby improving the risk profiling process. By incorporating both advisers can gain a deeper understanding of their clients’ needs and preferences. This can lead to more effective advice outcomes.
The third step is to discover the values and motivations of your clients, which are the underlying reasons and beliefs that drive their investment decisions. These can be shaped by culture, ethics, identity, and learning. For instance, some people may be influenced by the norms and expectations of their social and cultural groups, while others may be more concerned about the social and environmental impact of their investments. Additionally, some people may use their investments as a way of expressing their identity and personality, while others may be more curious and eager to learn new things. Through understanding the values and motivations of your clients, you can help them align their investments with their personal and professional goals to increase satisfaction and loyalty.
Some of us do feel sensitive to the environmental needs which in turn affects the future of the children. or not invest in food companies which are not good for health . Many AI programs are designed to understand a persons preference according to religion or cultural preferences. Nevertheless personal interactions to know these preferences are the best as there are companies which may not offer good returns but have other advantages as bonus shares or dividends basically it could be a slow moving scrip . hence its good to express clear intentions and honestly communicate the impact on returns.
Communicating effectively with your clients is the key to building trust and rapport. Factors such as style, frequency, channel, and content of communication should be considered when tailoring your messages and interactions to the needs of your clients. For instance, some people prefer more formal and structured communication, while others lean towards more informal and casual communication. Additionally, some people want more frequent and regular communication, while others want less or only when needed. Furthermore, some people favor more personal and face-to-face communication, while others favor more digital and remote communication. Additionally, some people want more detailed and technical information, while others want more simple and concise information. By understanding the communication preferences of your clients, you can avoid misunderstandings and conflicts. Behavioral finance can help you understand investor needs in a deeper and more comprehensive way, thereby improving your relationship and service quality. Following these four steps can help you apply behavioral finance to your practice and help your clients achieve their investment goals.
Communicate any way but be honest. And writing down pros and cons have been the best to succeed in everyway. Paper and Pen will always be the magical tools. what's in the mind comes up well on paper. I may sound old school but that can never replace any gadget.
Recent experience is of a stock split. I had taken a stock which was expensive but a small amount .was confident on the future of it but the price was hovering at a point when its expensive for people to buy. but as the company was done with the stock split it shot up like a rocket i could not believe the profit in a single day which was more than 10% profit.
Frame Information Appropriately: Present information in a way that minimizes the impact of behavioral biases. For instance, framing investment choices in terms of potential gains rather than losses may lead to different decisions. Understand Emotional Responses: Recognize the emotional aspects of investing. Investors may feel fear, greed, or regret, and these emotions can significantly impact decision-making. Acknowledging and addressing these emotions can help tailor investment advice.