A new and upcoming field, behavioral finance has made its way to the forefront of conversations related to consumers and the less predictable decisions they make. Most people are not yet familiar with the term; “behavioral” often is associated with the field of psychology, and “finance” with economics, so seeing them together might seem a bit strange. However, the term is quite simple and straightforward.
Behavioral finance seeks to find reason in the unexpected and unpredictable decisions or responses consumers have towards certain products and companies. Comprehending how and why people make the financial decisions they do allows for businesses to have a deeper understanding of audience response, thus allowing for businesses to find new ways to relate and appeal to consumers coming in their direction.
So, how do we assess such subjective responses? Perhaps the first thing to realize is that it is not so subjective after all. Basically, behavioral finance breaks down irrational, emotionally-dictated financial choices into a few sections: there is anchoring, hindsight and confirmation bias, gambler’s fallacy, mob mentality, overreaction, and overconfidence, just to name a handful. With these categories, researchers can break down the choices consumers make into more isolated areas, allowing for deeper analysis and understanding.
Anchoring, while might not seem too familiar of a term, is a large part of understanding a framework in of the biased behavioral choices in finance. Anchoring acknowledges that consumers may get fixated on an idea or object, which then causes them to feel attached to a financial responsibility that they are not obligated to. This is popularly seen with over-the-top engagement rings, the stock market, extravagant sweet sixteens, and higher education.
Consumers often feel pressure to conform to popular financial decisions, which roots them in the idea that they must follow the footsteps of mainstream expectations. This can result in splurging on items the consumer may not necessarily have the funds for or even necessitate, thus creating the potential for financial burden. Much of behavioral finance observes behaviors and tendencies similar to what happens in anchoring; the consumer feels social or societal pressure to distribute their finances the way “everyone else” has, which results in the making of irrational financial choices.
Often, consumers feel obligated to a lifestyle that is common and predictable in nature, despite its potential for not being the most financially savvy choice. Understanding the choices consumers make and why they make them can aide others in becoming more informed spenders, which can eventually alleviate financial stress in the long run. Taking the time to place spending habits under scrutiny might just be what saves you from missing next month’s rent for a thoughtless splurge on a fancy night out.