David Kinnear: Cognitive Biases and Behavioral Finance
Behavioral finance research examines the psychology and cognitive processes which engage when people negotiate a salary or make an important decision. Applying behavioral finance theories to situations beyond money and investing can be useful, as they provide humans with a metric to quantify the choices that they make everyday.
When people understand the psychological and emotional variables that affect their decision-making, they can live their lives more intentionally. More importantly, this knowledge functions as an antidote to the sense of inertia which often makes people “feel struck.” Writing for New York Magazine, Melissa Dahl articulates this insight into human behavior: “The big decisions of your life are hardly decisions at all,” she says. “People are drawn to the status quo.”
Human beings try to avoid the pain of regret. Although regret has an adaptive evolutionary basis–it helps people avoid future situations they may regret–this emotion often leads people to make choices that are maladaptive, that are not in their best interest.
Narrow Framing and Emotions
People who get caught in a narrow frame of thinking tend to overlook the full range of options available to them. Instead of seeing the fluidity and full range of a situation, a person may engage in black-or-white thinking. Narrow framing reveals the power that emotions wield over human decision-making.
Perhaps the most common issue in behavioral finance, confirmation bias blinds people to the possibility that they might be wrong. When faced with information that appears vaguely familiar, people tend to overvalue news that reinforces their previously-held beliefs. Conversely, people tend to neglect the importance of bad news which discredits the choices they made in the past.
As researchers make new discoveries about human neuroscience and psychology, people will have more opportunities to examine their own behavior. Understanding why you do the things you do may become a bit easier, In the future.