27 JUN, 2023
By Constanza Ramos
Some biases, such as extrapolation or overconfidence, are part of the consequences that can be caused by letting ourselves be carried away by our emotions when it comes to saving.
Gonzalo Viveros, economist at Altafid, and Hugo Aravena, president of the CFA Society Chile, give us their comments below, highlighting the importance of personal financial planning and contrasting investment hypotheses with opposing opinions, among other things.
Evidence shows that people are susceptible to emotions and psychological biases when saving and investing, including professional investors. These errors can compromise personal wealth.
Among the biases that have been studied are extrapolation, overconfidence, and the asymmetric disposition we have toward gains and losses.
Extrapolation refers to the failure to make adequate statistical inference, tending to project the future based on events that are subjectively more significant, such as more recent events.
Overconfidence makes us think that our investment performance depends on our own decisions alone, leaving aside the fact that in reality not everything is in our hands.
The asymmetric disposition makes us suffer more from a loss of a given amount than from a gain of the same amount, losing sight of the ultimate wealth.
These behaviours can lead us to make mistakes. For example, the asymmetric disposition pushes us to liquidate our investments early in order to "realise gains", even if they have the potential to continue to perform well. The opposite happens with losses: in order not to realise losses, we hold investments that could continue to lose value. This behaviour can also be tax inefficient.
Human beings are emotional and emotions influence many aspects of our lives, including, of course, investment and savings decisions, and especially when it comes to personal finance, where they certainly affect the way we invest.
The evidence on this subject is extensive. In the 1970s, the study of emotions in finance began, leading to the emergence of behavioural economics, whose main exponent is the psychologist Daniel Kahneman, winner of the Nobel Prize in Economics.
In this line, we can observe that when we feel confident, it is common to make risky and hasty investment decisions. On the other hand, when we are overwhelmed by uncertainty, low-risk and overly cautious decisions tend to be made.
This explains why when gains are made, the same decisions are not made as when losses are made, as investors emotionally value them differently.
Another example is when a friend or close friend tells us that he or she has obtained high returns by investing in certain assets and there is concern about investing in them, for fear of losing a possible good investment. This leads people to rush into investing, instead of taking their time to analyze.
Some tips that can be useful to save more and better, without being carried away by emotions, are: planning personal finances, contrasting investment hypotheses we have with contrary opinions, counting on the advice of experts in the area, and, advancing in the knowledge of fundamental variables in investment such as diversification and analysis of investment costs.
In short, the study of emotions in finance has allowed us to become aware of how they impact our savings and investment decisions. In this way, we can avoid reactions that could damage hard-earned gains, allowing the financial market to function as an ally in the fulfilment of our personal goals.
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