Behavioural psychology is the root of every financial decision we make. Prasad Ramani, Founder, Syntoniq says that the idea behind behavioural psychology is to figure out how to get better at using psychological factors that help in making right financial decisions.
Referring to Daniel Kahneman as the godfather of behavioural economics, Prasad described Daniel’s concept of thinking fast and slow. The brain has two ways of processing information - system 1 and system 2. System 1 is fast, automatic, instinctive and emotional. Here decisions are made at the spur of the moment. While system 2 is slow, effortful, deliberative and logical. Most of the problems in life arise because of the gap between these two systems. Instead of using system 2 investors often end up using System 1.
Irrational decisions arise from mental shortcuts which are due to cognitive limitations, imperfect information and time constraints. Mental shortcuts result in quick decisions and conserve time, energy and effort. However, it has downsides when applied in the financial domain. The human brain is not wired to respond to financial markets differently and that is why investors tend to hold on to losers, concentrated portfolios, overtrading, investing in more ‘recognizable’ names and impulsive reactions.
With this in mind, Prasad familiarized the audience at Cafemutual Confluence Investment Marathon 2021 with the concept of 3Bs i.e. Biases, Behaviours and Blind spots that they need to be aware of.
- Biases are mental pitfalls that subconsciously affect financial decisions. Overconfidence is one such example. Research shows overconfident investors tend to transact more and have concentrated portfolios as they are sure they will get it right
- Behaviours are the preferences that shape individuals’ financial choices and outlook. For example, loss aversion is where losses hurt more than gains of a similar nature. Though the monetary value is the same, their impact is different
- Blind spots are the gaps between what investors think they know and what they really know. For example, assuming financial mastery. However, there is no harm in admitting limited financial expertise. Investors should approach financial advisors for their expertise
Prasad believes that adopting a few behavioural attitudes can help to become better at investing.
- Life is non-deterministic i.e. what we think will happen for sure may not happen
- Be actively open-minded i.e. be ready to change your initial hypothesis, get conflicting information and think about it with an open mind
- Need for cognition requires spending a little bit more time in making decisions rather than rushing into it
- Reflective updates require looking into new information flow carefully
- If something is too good to be true it requires caution
Additionally, maintaining an investment journal helps in improving the quality of decisions over time. Investors should write down why they are making a particular investment decision today. Recording and analysing helps in understanding decision-making patterns and reducing negative outcomes.
To sum up, Prasad helped the audience to be aware of biases, behaviour and blind spots. What made it more interesting were his practical tips for becoming a better investor.
Watch this video to understand the 3Bs in detail and how to make informed choices.
