Behavioral Finance

Subtopic: Wine Varietals Air Date: October 9th, 2020

As you’ve learned in previous weeks, ideas and foundations for money/finance is rooted very early in life. Because of this it is extremely difficult to change people’s perspectives. Financial matters remain the leading cause of stress based on a 2018 survey.

What is it influencing us? Mass media, other’s behaviors and advertising, life experiences (especially major life events like 2008 and COVID and 9/11). So this week we are focusing on psychology and finance. Better known as behavioral finance.

  1. Delayed gratification- Walter Mischel, a professor at Stanford conducted a study to better understand control of delayed gratification. Simple study, a child was given a marshmallow, however if they waited 15 minutes they would receive two marshmallows. The children who waited those 15 minutes proved to do better in many aspects of life (SAT scores, educational attainment, etc.) How is this relevant to finances? Because many young adults don’t save. They feel as though they have plenty of time and why start now.
  2. Loss Aversion – this study can be performed easily when you test whether losing $150 or finding $150 will affect you greater. This occurs more strongly when clients have experienced the ‘Snake Bite Effect’ – it’s natural for people who have lived through or viewed a negative experience to be overly cautious or adverse to loss.
  3. Recency Bias – the latest greatest thing is going to catch your attention. We see that not just in finance with product driven companies wooing clients with the latest and greatest, but across all aspects of life. This is where those influencers such as advertising and mass media play a huge role.
  4. Mental Accounting – This bias can greatly affect save vs. spend. This bias focuses on clients that compartmentalize accounts by the way they were obtained. A good example of this is a client that has inherited a large sum. Most often if that client has already been saving, they will see the windfall as “play money” and will carelessly spend rather than save. We see this also with people who win the lottery.