An Investor’s Guide To Behavioural Economics | ET Money

Behavioural economics brings together elements of economics and psychology in the real world to understand how and why people behave in the way they do. In other words, it’s a study of what people “should” do, what they “actually” do and the consequences of those actions. This makes behavioural economics a lot different from the traditional neoclassical economics which assumes that most people have well-defined preferences and every human makes well-informed and rational decisions.

📝 RESOURCES:

Misbehaving: The Making of Behavioural Economics (https://amzn.to/3P7w9CJ)
Nudge: Improving Decisions About Health, Wealth and Happiness (https://amzn.to/3bVYWfm)
https://news.uchicago.edu/explainer/what-is-behavioural-economics
https://www.manulifeim.com/content/mim/ca/en/resources/all/others/using-behavioural-economics-to-help-clients-make-better-financial-decisions/_jcr_content.download
https://thedecisionlab.com/
https://fs.blog/behavioral-economics-reading-list/

CHAPTERS

00:00 Introduction
01:56 Investing Anomalies And Baises
08:40 Strategies And Tactics To Combat Biases

📝 INVESTING ANOMALIES AND BIASES
AVAILABILITY HEURISTICS
More often than not, people rely on easily recalled or presented information rather than actual data when making a decision or evaluating the likelihood of a particular outcome. This is known as “availability heuristic” and it describes our tendency to use half-processed and readily available information that comes quickly and easily to our minds.

BOUNDED RATIONALITY
The next anomaly I’d like to put forth is bounded rationality which is the theory that the decision making process loses some of it’s rationality on account of any of these 3 factors i.e. in cases where there is limited cognitive ability, in case of imperfect information and also when there are time constraints.

PROSPECT THEORY
A third anomaly worth looking at is the prospect theory which says that investors value gains and losses differently and often place a greater weight on perceived gains as compared to perceived losses.

HYPERBOLIC DISCOUNTING
It’s a very interesting behaviour which says that people prefer to choose smaller and immediate rewards rather than larger but later ones and more importantly, this occurs more when the delay is closer to the present than the future.

MENTAL ACCOUNTING
The concept of mental accounting explains how we tend to assign subjective values to our money depending on how we earned the money, how we intend to use it and how it makes us feel. In the case of investing, mental accounting shows up when some investor divides his or her investment as a safe portfolio and a speculative one.
📝 STRATEGIES TO COMBAT BIASES
SYSTEM 2 THINKING
So system 1 is fast and automatic but system 2 thinking is a deliberative, careful and a very reflective way of decision-making. Essentially, System 2 thinking says that when making an important decision, one should always take a step back to ensure that there isn’t something in the way that is distorting one’s view.

PRE-COMMITMENT
A second technique that can really alleviate biases is pre-commitment. So essentially, pre-commitment as the name suggests is about making it clear to oneself on what your goals are, what your plan is and what you are committing to.

THE NUDGE
The third behavioural economics mitigation strategy is what is popularly known as a nudge. So, a nudge in behavioural economics is a way of manipulating people’s choices by leading them to make specific decisions. Nudge is never coercive so banning junk food or punishing people for not opting healthier options is not a nudge. Infact a nudge should be developed very seamlessly into the environment to have its greatest impact.

THE BEGINNER’S MINDSET & TEAM WORK

— SHUNRYU SUZUKI

You see, a beginner’s mind is without preconceptions which means it is not bound by rationality which then opens it to a lot more possibilities as compared to an expert’s mind. Further, the beginner’s mind is often not conflicted in asking for help and working with a group or within a team is an excellent way of overcoming some limitations and presenting a superior solution. In investing, this comes in the form of educating oneself with books, newsletters, youtube videos etc. joining mastermind groups where people discuss investing, taking the services of a financial advisor etc.

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