Behavioral Finance: FOMO, and Investing Biases

What takes place in investors’ minds when they buy assets, hold on to stocks, trim their positions and make other decisions with their capital? Knowing how investors think can lead to a better understanding of financial markets and help you make better investing decisions.

“Behavioral finance studies why investors make decisions for and against their best interests,” says William F. Spencer, a certified financial planner, director and wealth planner at Crestwood Advisors. “It looks at cognitive and emotional biases that help us make sense of the world.”

While it’s hard to guess every thought that goes through an investor’s mind, there is a branch of finance that covers this topic. Behavioral finance explores some of the common patterns and biases that shape investors’ actions and, ultimately, their portfolios.

How Behavioral Finance Affects the Stock Market

The stock market presents investors with many data points that can help them make well-informed, logical decisions. While we have the resources to make logical decisions, emotions drive most of our decisions. According to research from Nobel Prize-winning psychologist Daniel Kahneman, emotions are in the driver’s seat for 90% of our financial decisions.

Emotional investing lets things like fear, ego, greed and sadness get in the way of sound investment decisions. Kahneman’s research points to financial professionals, in particular, who may believe they are immune to financial biases due to their expertise.