BEHAVIOR

Do we really make rational decisions?

What if I told you that our emotions, often unconscious, influence a large part of our choices?

Imagine life as a journey. Emotions are our compass, guiding us in the direction we should take

Examples in the context of Behavioral Finance:

• Endowment effect: We tend to assign more value to things we own, even if their objective market value hasn't changed. This leads us to ask for higher prices when selling and to be reluctant to part with possessions, even if we don't use them anymore.

  • Practical example: We tend to hold onto stocks that are losing value, hoping for a recovery, rather than selling and realizing a loss.

• Loss aversion: We feel the pain of a loss more intensely than the pleasure of an equal gain. This leads us to make risky decisions to avoid a loss, even if the situation could worsen.

  • Practical example: We continue to invest in a mutual fund that is losing value, hoping to recover our losses, rather than diversifying our portfolio.

• Illusion of control: We tend to overestimate our ability to influence uncertain events, such as stock market movements. This leads us to make investment decisions based on intuition or incomplete information, rather than on rational analysis.

  • Practical example: We choose to invest in a single stock because we have a "good feeling" about it, rather than basing our decision on data and thorough analysis.

• Overconfidence: We tend to overestimate our knowledge and our ability to predict the future. This leads us to make risky decisions and underestimate potential risks.

  • Practical example: We believe we can predict the market and invest all our capital in a single trade, rather than diversifying the risk.

Examples in the context of Emotional Behavior:

• Impulsive buying: We often buy products we don't really need, driven by emotions like desire, impulsiveness, or the need to feel good.

  • Practical example: We buy expensive clothes during a sale, even if we don't need anything new, just because we feel the need to get a bargain.

• Fear-based decisions: Fear of the future or of losing something can lead us to make irrational decisions and give up opportunities.

  • Practical example: We turn down an interesting job offer because we are afraid to leave our comfort zone.

• Group influence: We tend to conform to the opinions and behaviors of the people around us, even when we know they are not rational.

  • Practical example: We invest in a particular stock just because all our friends are doing it, without doing our own thorough analysis.

• Confirmation bias: We tend to seek information that confirms our pre-existing beliefs, ignoring or discarding evidence to the contrary.

  • Practical example: We continue to believe in an investment idea, even if there is evidence that it is wrong, because we have already formed an opinion about it.

Why is it important to understand these concepts?

Understanding these cognitive biases and our emotional reactions allows us to make more informed and rational decisions, both in our financial lives and in our personal lives. By adopting strategies to mitigate the impact of these biases, we can improve our choices and achieve our goals more effectively.

In conclusion, both in finance and in everyday life, our emotions and cognitive biases significantly influence our choices. By understanding these mechanisms, we can make more rational decisions and achieve greater well-being.