What is behavioural finance?
Traditional finance theory assumed that investors are well-informed, careful and rational when making financial decisions. However, in reality humans are emotional beings and beautifully irrational, especially in long term activities such as investing. Behavioural finance takes into account research from psychology and empirical evidence to develop an understanding of financial decision making. Below are five common behavioural finance-related mistakes that most us make when investing:
Optimism bias: Behavioral research indicates that investors are overconfident with respect to making gains and oversensitive to making losses. There is also a tendency for individuals to place too much confidence in their own opinions & investment decisions, ignoring the real and alternative possibilities of their decisions. Investors who are overconfident tend to buy and less investors more often, which actually leads to lower returns compared to a simple buy and hold strategy.