The Definition of Behavioral Finance

Expert Insights

Sampath Kumar

Professor of Marketing for the Austin E. Cofrin School of Business at UW-Green Bay

What do you think is the most important thing individuals need to know about behavioral finance?

Behavioral finance combines psychology and economics. People are often not rational when it comes to their behavior. Economics assumes people are rational, but they are often not in real life. Thus, we need to protect our finances from our emotional mood swings. The most important thing individuals need to know about behavioral finance is that we are not always rational decision-makers. This means that we can make mistakes, just like everyone else. It is important to be aware of our own biases and to try to make decisions that are in our best interests, even when it is difficult.

Do you have any tips on how people can apply behavioral finance assessment when making financial and investment decisions?

Here are some key behavioral finance principles that can be applied to financial and investment decisions:

  • Automate Savings: Automate your savings by setting up regular contributions to your 401(k) or IRA. This strategy makes saving effortless and removes the temptation to spend the money that is automatically deducted from your paycheck.
  • Avoid Emotion-Driven Decisions: Avoid making financial decisions when you are experiencing strong emotions, such as anger, excitement or sadness. These emotions can cloud your judgment and lead to impulsive choices you may regret later.
  • Save for Large Purchases: Instead of financing significant purchases with debt, plan and save for them in advance. This approach allows you to enjoy the purchase without the burden of debt.
  • Account for Additional Expenses: When considering large purchases like a home, factor in additional expenses beyond the sticker price. Consider costs like furniture, repairs and renovations to avoid financial strain.
  • Plan Holiday Purchases Strategically: Plan your holiday spending in advance to avoid overspending during the holiday season. Create a shopping list and stick to it to avoid impulse purchases.
  • Minimize Shopping Trips: Reduce the frequency of your shopping trips to minimize spending. When purchasing groceries, stick to grocery stores and avoid large retail stores where unrelated items may tempt you.

By incorporating these behavioral finance principles into your financial decision-making process, you can make more informed, rational, and successful financial choices.

Source: The Definition of Behavioral Finance

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