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Much of the traditional financial models
are based on the assumptions that
individuals act rationally and process all available information in their
decision-making process. People often make systematic
errors (cognitive biases) which lead them to deviate
from rational behavior expected of an investor. Behavioral finance attempts to merge
concepts from financial economics and cognitive psychology as an attempt to understand how
the systematic biases in the decision-making
process influences different dimensions of
financial markets. Capital market offers an array
of investment products like shares, loan stocks, bonds, warrants, and unit trusts. Different
people invest with different intentions. The
investment(s) chosen by an investor depends largely on
his financial goals, time frame, amount of capital available, etc. It has also been observed that,
often investors buy stocks on a whim or on the recommendation of others when they should
buy stocks that are showing fundamental strength
and are consistent with their investment objectives.
To the risk-taking appetite of investors
depends on factors like socioeconomic background, educational attainment level, age, race and
gender. The most crucial challenge faced by investors is
in the area of investment decisions. An optimum investment decision plays an active role and is
a significant consideration. In designing the investment portfolio, investors should
consider their financial goals, risk tolerance level, and
other constraints. This needs better insight, and understanding of human nature in the
existing global perspective, plus development of fine
skills and ability to get the best out of the investments.
In addition, investors have to develop a positive vision, foresight, perseverance and drive. In
the present scenario, behavioral finance is
becoming an integral part of the decision-making
process, because it heavily influences investors'
behavior. An investor can improve his investment performance by recognizing the biases and
errors of judgment to which all are prone.
Understanding behavioral finance will help the investors to
select a better investment instrument and hence
avoid repeating expensive errors in future. The
pertinent issues of this analytical study are how to
minimize or eliminate the psychological biases in
investment decision making. The reason behind this
anomaly is that successful investments require
many things. The first is the discipline to follow
the chosen investment strategy. Next, is the ability
to choose the proper stocks by doing research or using the services of professionals in the field
of investments. Finally, and most importantly, it is
to be clearly understood that stock prices in the
short run are more a function of people's emotions
than the fundamentals of the underlying companies. This is where most investors lose out. They
fall prey to their own, and sometimes others',
mistakes due to the use of emotions in financial
decision-making. This often repeated phenomenon was
the genesis of the branch of finance known as Behavioral Finance.
However, it is important to mention here that Behavioral Finance only provides us with
a framework to try and outperform the market by being aware of our emotions, as well as those
of others, and using this information to our
advantage. It in no way is a remedy to master the art of
stock picking. It does not involve models or formulae
to help us pick the right stocks at the right
price. Hence, one needs to understand that there
can never be any sure shot way to make money,
either on the stock markets or anywhere else. |
