What is Behavioral Finance?

When it comes to discussing economics and finances, the term behavioral finance comes up more and more often these days. This somewhat new concept refers to a new field of study that assesses the reasons why people make certain monetary decisions. Whether these decisions be positive decisions or they have a negative outcome, it is important to look at the various cognitive and behavioral reasoning for finances and economics. When it pertains to money, personal financial decisions affect a family and their financial stability. However, these decisions can also greatly impact the nation’s economy. Consumerism and investment opportunities allow people to contribute to our economy. It is interesting to look at why these contributions are made and the thought process behind the decision making.

Personal Accounting

Part of behavioral finance relates to the mental accounting that people often do when it comes to their money and their budget. Each time a person gets paid, they often allot certain amounts of money to different areas of a budget. There is usually a bills area that includes a housing and utilities, as well as a spending area for groceries, gas, and activities. Depending on the amount of money available, people may have to make tough decisions about where to place the money. In tight times, this could mean a difference in housing and groceries. In foolish times, this could mean a decision to eat out instead of paying a utility bill. All of the motivations behind these decisions are at play in the study of behavioral finance.

Paying Attention To Other Information

There are many people who make financial decisions based off of what other people around them are doing. If everyone else is investing in a certain stock, it might seem like the right decision to also invest in that stock, without doing any research. Forbes states that many people make financial decisions based on an anchor point of information. This could be a suggested dollar amount for savings or an advertised price decrease. Regardless of where the information comes from, people make decisions based on partial information and lack of research.

Common Prices

The prices people are willing to pay for items may be determined in relation to other comparable prices in the market. Clothing in a high end boutique priced at $100 may seem relatively normal because it is comparable to other high end stores. However, that could be over-priced when compared to similar clothing available in other retailers. Because the price is similar to that of other retailers, it seems normal to spend more money in that way.

Behavioral finance helps to apply some psychological backing to the financial decisions we make. Understanding these factors how they impact each and every one of us can help us all to make better financial decisions.