The Investment Scientist

8 Behaviors That Affect Financial Decisions

Posted on: March 17, 2011

This list is taken from an Irish Times article on behavioral economics.

1. LOSS AVERSION

People are more motivated by fear of a loss than hope of a gain, hence are more likely to seek to avoid a penalty than seek to gain bonus, even if both amount to the same thing.

2. ILLUSION OF CONTROL

For example, people feel an illusion of control when they’re allowed pick their own lottery numbers, even though they are no more likely to win by being given this choice.

3. DENOMINATION EFFECT

The tendency to spend more money when it’s denominated in small amounts (like coins) as opposed to large amounts (like large notes).

4. ANCHORING

Once a specific anchor is implanted, other important details get overlooked in decision making. So, if buying a car, people might get hung up on the year of the car, or even the colour of the car, rather than other more pertinant issues, like well it’s been maintained.

5. MONEY ILLUSION

There’s a tendency to think of currency as having a real value unlinked to its purchasing power. So, in experiments people think of a 2% pay cut as unfair, but a 2% rise in income where there’s been 4% inflation, as fair.

6. REACTANCE

Basically reverse psychology. Marketing professionals often plaster games packaging with warning labels and age prohibitions knowing this will make some more eager to buy them.

7. POST-PURCHASE RATIONALISATION

People will overlook problems with a product to justify their decision in purchasing it in the first place.

8. BANDWAGON EFFECT

The tendency to do or believe something because many others are doing or believing the same (anyone who fell foul of the property bubble will be familiar with this).

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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