behavioral finance assignment help

behavioral finance assignment help

The Importance of Behavioral Finance in Making Financial Decisions

1. Introduction

Investors throughout the globe are faced with increasingly complex investment decisions amidst mixed views on how to build and manage diversified investment portfolios that meet financial needs. An increased awareness of beneficial lifestyle choices by employees can ultimately decrease overall company healthcare expenses and increase productivity. With a growing emphasis on healthcare reform and the demand on employers to control costs, promoting employee engagement in personal health can play a critical role in revitalizing company wellness programs. A plethora of savings and investment products are now at the disposal of investors and people often rely on their financial adviser to provide the appropriate level of guidance. Others may decide to act independently, totally disregarding the emotional aspects of financial decision-making in the process. This often results in suboptimal financial decisions based not on sound investment principles but on subjective reasons. However, making decisions on the basis of desk research is not easy. The aim of this paper is to apply some theories of behavioral finance to a case study on the determination of the structure of a balanced portfolio, taking into account six assets from two different perspectives.

Behavioral economics has increasingly gained popularity among researchers due to its importance when it comes to behavioral aspects. The development of financial models with respect to the behavioral aspects of both the financial market and its main participants is growing. In many cases, behavioral finance explains the irrationality when it comes to financial markets and the existence of many anomalies when it comes to the behavior of financial analysts. Trading by private investors has become a popular topic for financial researchers. In addition, the ability to control emotional decision-making can positively affect how investors undertake speculative economic activities, such as investments. Financial wellness has become an increasingly important dialogue as organizations shift the vision from employee satisfaction to that of employee well-being. Given the increasing employee contribution to retirement, employee investment decisions and behaviors are becoming paramount to the achievement of financial objectives.

2. Understanding Behavioral Finance

Behavioral finance also examines market prices and nonstandard decision making that may result from factors other than risk aversion. It acknowledges that financial decision making may have blind spots and is influenced by neural factors such as reference dependence, regret avoidance, loss aversion, and prudence. Other causes of cognitive biases include decision making fallacies and heterogeneity in investment objectives.

Behavioral finance refers to the study of the practical implications of the behavior of finance. The aim is to integrate psychological theories like cognitive psychology and social psychology to describe the behaviors of investors and their impact on market prices. This field investigates anomalies in market pricing and nonstandard decision making based on psychological attributes of investors.

3. The Impact of Behavioral Biases on Investment Decisions

The main implication of the efficient market hypothesis with respect to stock prices is that no one can persistently earn abnormal profit by carefully selecting one stock over the other. This does not imply that individuals are rational in their expectations. Indeed, the efficient market hypothesis does not require that people be rational in their expectations. Behavioral finance accommodates the findings from psychology and overconfidence, mainly centering on two explanations: behavioral finance often refers to the findings from the psychology and overconfidence literature to explain stock prices. Since social scientific evidence suggests that people are overconfident about their ability, behavioral finance models often incorporate overconfidence by replacing the assumption of rational expectations in traditional finance with overconfident expectations.

Behavioral finance argues that some market prices may be wrong, and that in such cases, financial models and theories have no power, while traditional finance does not provide a plausible explanation of why an intelligent investor would not take advantage of a situation where the path is paved with dollar bills.

According to the efficient market hypothesis, stocks always trade at the fair value, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. It is the price of stocks that fluctuates rather than the intrinsic value of them. Therefore, the implication of the theory is that it is impossible to outperform the market through expert stock selection or market timing, and that the only way an investor can obtain higher returns is by purchasing riskier investments.

4. Strategies to Overcome Behavioral Biases

The next strategy that needs to be further considered by investors is to choose counterparties in trading transactions to avoid investment decisions based on emotions. In addition, investors must also pay attention to the trading frequency and reduce negative effects through investment diversification and by making decisions wisely. Diversification is generally expected as a strategy to reduce the risk associated with investing in any stock compared to the market portfolio by placing investments in various assets to reduce unsystematic risk.

The third strategy that needs attention is that every decision to invest must be adaptive, for example, by making rational responses when others adopt the herding effect. This is intended so as not to react irrationally or emotionally when other market participants move together or influence decisions to invest through the herding effect.

The second strategy that must be done by investors is to pay attention to rumors conveyed to avoid herding effects when collecting information about investment decisions. The higher the level of consensus among analysts, the observed herding effect will increase. Therefore, market participants must have the ability to identify and manage common entrenched risks more effectively.

4. Strategies to overcome behavioral biases. Every investor must have a self-assessment of his or her financial dealings to avoid making irrational or emotional decisions, such as herding effects by following the group when making investment decisions. Thus, the recommendation for investors is to avoid implementing the herding or follow-the-leader effects with a style approach.

5. Conclusion

Of course, finance can’t be completely held accountable for this behavior because investors also relied on professional money managers to make responsible decisions. With social media platforms, people have become more informed, and bullish hype can attract investors. For example, since 1998, the volume of content on the InvestorHub forum, Yahoo Finance’s message board, Reddit, and Twitter has skyrocketed. While professional managers always had a good understanding of market inefficiencies and grasped the opportunity. Today’s small traders may have more trading information than the pros given the diverging incentives and information accessibility from social media in the digital age. Behavioral finance assumes that individuals recognize a good deal from a risky situation in traditional financial theories.

While behavioral finance offers a fresh perspective on how financial markets unfold, many critics often highlight the shortfalls of behavioral finance and its ability to explain away anomalies. Some of these problems can be attributed to the vague categorization of these explanations. The underlying theory under behavioral finance, however, is consistent. For instance, one can view the impact of the irrationality in financial decisions. Since the future is riddled with uncertainty, it’s a fundamental human pattern to simplify complexity decision making under ambiguity. Over time, individuals have developed heuristics, which short-circuit the burden of large processing. The vulnerability characteristic of this process must spawn powerful forces—like culture, markets, and government regulation—overcoming these pitfalls.