Written by: Souki Fournier
To be able to fully understand an investor’s decision-making process, financial advisors need to equip themselves with the knowledge, skills, and understanding of Behavioral Finance.
When taken right back to the bare bones of it all, a human being’s most basic natural instincts are based on emotions and psychological reactions triggered by a variety of events. When it comes to making investment decisions, these natural reactions are brought into this as well.
A second way that humans make decisions is through conscious thinking. Now, these behaviors are slightly different from survival behaviors because they are learned as a result of experience, and so people are able to adapt to changes in their environment.
These natural instincts as well as the learned behaviors, all carry across into the financial decision-making actions that people act upon.
1. What is Behavioral Finance?
Behavior Finance is essentially understanding the underlying psychology of financial decision-making. It combines cognitive psychology with economics and finance.
The objectives of Behavioral Finance are to understand why individuals make certain investment decisions.
- Emotions are responsible for our quick assessments that influence financial decision-making. Positive emotions lead to more risk-taking, optimism, and in addition, buying decisions are made faster. Investors are well aware of the roller coaster of emotions they go through including hope, excitement, euphoria, fear, despair, regret, and sadness.
- Another example is Herd Mentality. Herd Mentality is when a person feels pressured into making a decision just to conform with the largest crowd and their rationale behind it is that ‘so many people are doing it, it must be right.’ The dotcom bubble is a perfect example of this. Between 1995 and 2000, investors were backing internet-based startups hoping that they would soon make a profit.
2. We all have biases
We all have Behavioral Biases which are irrational beliefs or behaviors that can unconsciously influence our decision-making, and stray us from rational decision-making.
However, our biases lead us to make less than optimal decisions.
The Behavioral Biases embedded in humans are responsible for irrational decisions that result in poor financial or insurance investment. We need to be made aware of our personal biases and try not to let them influence our financial decision-making.
As Hugh Massie, our CEO and Behavioral Strategist explains, we focus on 16 Behavioral Biases that affect people’s financial decision-making. Once you can identify and understand your top two or three biases, you can become a better decision-maker, especially when under pressure.
3. Spending patterns are written all over us
Behavioral Finance is the answer for advisors who want to learn more about investors and how they intend to spend their money.
It has typically been a problem that advisors haven’t had enough information and insight into their clients’ spending patterns and as such, could only create financial plans without truly understanding what people planned on investing in or saving up long-term.
4. You can’t spell “behavior” without “risk” in it
By now, as an advisor, you should be able to understand that a person’s behavior is intrinsically coupled with the amount of risk they are willing to take. To be able to help your investors experience long-term financial success, determining their risk factor will play a major role in determining their strategy.
When you choose to work with us, you will benefit from our Financial DNA reports that provide a step-by-step approach to determining the risk behavior of clients, couples, and advisors.
You see, every single person has a Risk Behavior number ranging from 0 to 100, and it’s based on their Risk Tolerance and Risk Propensity. A higher score means they are more likely to take risks. The score is normally distributed with an average of 50 and a standard deviation of 10.
5. Financial DNA takes the guesswork out of investing
When you work with us, we help you build a system to understand your clients, where you will be able to connect with them, and customize their experiences.
By understanding your client you will be able to communicate with them in a more relatable manner; you will to know and understand their risk behaviors and spending patterns and it will be easier to understand and determine their financial goals.
Our Financial DNA API sets us apart because it measures 500+ behavioral insights and will be a way to add a human element to your data. This is done with details on how people communicate, invest, work and live their life.
At Financial DNA, we have years of experience to help you better understand your clients. If you are interested in our Financial DNA investor experience, basic Financial DNA reports, and 1:1 onboard coaching, start a free trial today.
Related: Who Rules the Money?