Beyond numbers: Why behavioral finance is crucial for finance careers
Want to know more about behavioral finance? Here's how it can improve your investment process and relationships with clients and colleagues.
When it comes to finance, it’s easy to assume that rationality wins out. That investors make logical and rational decisions based on data, facts and models. That markets are efficient.
In real life, however, there’s much more at play.
When it comes to making financial decisions, our biases, emotions and influences often affect our choices. We may not like to admit it, but at times, we act irrationally.
The study of how psychological factors and cognitive biases influence financial decisions is known as behavioral finance.
While not a new concept (it first emerged as a field in the 1980s), behavioral finance has gained prominence in the decades since.
Now, for anyone serious about having a successful finance career, it could be argued that having an understanding and being able to implement the principles of behavioral finance isn’t just a nice-to-have, it’s essential.
Here, we explain why.
Better decision-making
Whatever your speciality, in finance you make decisions on a daily basis. These decisions can have far-reaching implications for investments, corporate strategy, client portfolios and risk management.
The stakes are often high so being able to make informed, rational decisions is crucial. Behavioral finance principles can help.
Incorporating them into your decision-making processes means you’re better able to:
- Recognize biases
- Understand emotions
- Anticipate market behavior
- Think more strategically
While it’s important to be able to identify clients’ cognitive biases and emotional triggers to help them make better financial decisions, it’s just as important to be aware of your own. This also applies if you’re in a non-client-facing role. Why? Because your own internal biases and triggers can subtly influence critical decisions without you realizing and this could lead to poor outcomes for you and your company.
You want to avoid common pitfalls that even seasoned professionals fall into at times, such as herd behavior and overconfidence, and make rational, informed choices.
Stronger client relationships
When you understand client biases, you can provide a more holistic, empathetic and personalized service.
For example, if you know your client has a tendency to panic sell on the back of negative headlines, you can proactively reach out and help them avoid making hasty decisions.
Research shows clients prioritize the personal relationship they have with their adviser over other factors such as cost and performance. That’s certainly the case for Kate Freeman, CFA, Financial Advisor at UBS.
“So I have learned to identify the bias and then work with the client to understand that bias and that really requires the client having trust with you to share that emotion. It requires a vulnerability and that's the fun part of the job” she explained.
By understanding and implementing behavioral finance principles, you can build stronger connections, foster trust and create a more successful and enduring client-adviser relationship.
As Sreeni Meka, CFA, a Financial Advisor at Lakeland Wealth Management, said: “Understanding the client's psychology, how behavioral economics works, that's what makes you a better investor.”
Better communication
Communication is key in finance. Whether you’re dealing with clients or fellow colleagues, being able to communicate ideas, information and complex concepts is a crucial skill.
Understanding clients' emotional and psychological triggers and biases allows you to articulate your advice more clearly and in a way that’s accessible and relatable. It also means you’re better able to deliver your advice at the right time, minimizing the impact of biases or other influences.
With colleagues, having a grasp of behavioral finance principles gives you an insight into their decision-making process, leading to better collaboration.
If you know and recognize your colleagues’ triggers and biases, you'll be better able to preempt disagreements and create a more open, collaborative work environment.
Career advancement
A solid grounding in behavioral finance sets you apart from others in your field.
As more companies recognize the advantages of behavioral finance, having knowledge of it will help you stand out.
It may open doors to roles and projects that specifically require expertise in investor behavior - such as behavioral finance analyst or investment strategist - and could position you for leadership roles.
These skills enable you to better manage diverse teams who may have members with various biases and emotional responses and can help you handle panic or irrational behavior during crises or times of market volatility, both within the organization and among clients.
Crucially through, finance professionals seem to genuinely enjoy learning about behavioral finance and adopting it in their work. .
Luis Gonzali, CFA, Vice President and Co-Chief of Investments at Franklin Templeton, Mexico. said: “I fell in love with behavioral finance and behavioral economic topics. It was an eye opener for me.
“As a matter of fact, when I was picking my undergraduate degree, I was between mathematics and psychology. I chose mathematics, but I always liked psychology, so when I found out about behavioral finance, it was very enlightening, it was very satisfactory to know how to apply them to my daily job.”
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