Published: 12:32 PM, Jun 20, 2023
Photo by Shubham Dhage on Unsplash
Investment decisions are not solely based on cold, hard facts and figures. Emotional and social factors also play a significant role in how we choose to invest our money. This article will explore these influences on investment decisions, focusing on the UK context.
Mental Accounting and Investment Decisions
Mental accounting is a concept associated with the work of Richard Thaler. According to Thaler, people think of value in relative rather than absolute terms. They derive pleasure not just from an object's value, but also the quality of the deal – its transaction utility. In addition, humans often fail to fully consider opportunity costs (tradeoffs) and are susceptible to the sunk cost fallacy.
Even seasoned investors are susceptible to this bias when they view recent gains as disposable "house money" that can be used in high-risk investments. In doing so, they make decisions on each mental account separately, losing out on the big picture of the portfolio.
The Emotional and Social Drivers of Investment Decisions
Emotions can significantly impact our investment decisions. For instance, fear and greed are two powerful emotions that can drive our investment choices. Fear can cause us to be overly cautious and miss out on potentially profitable investments, while greed can lead us to take on too much risk in the hope of achieving high returns.
Social factors also influence our investment decisions. We are often influenced by the opinions and actions of others, whether they are family, friends, or financial gurus. This herd mentality can lead to irrational investment decisions, such as buying into a booming market or selling out in a crash.
Managing Emotions and Social Influences in Investment Decisions
Understanding the emotional and social drivers of investment decisions is the first step towards managing them effectively. It's important to be aware of these influences and to make conscious efforts to mitigate their impact on our investment decisions.
This might involve taking a step back to objectively assess our investment choices, seeking independent advice, or implementing a disciplined investment strategy that includes regular reviews and adjustments based on market conditions and personal financial goals.
In conclusion, the art of making investment decisions involves not only understanding financial fundamentals but also managing the emotional and social influences that can sway our choices. By acknowledging and addressing these factors, we can make more informed and rational investment decisions.
Liza Pringle is the dynamic force behind Enable Funding, a platform dedicated to providing in-depth insights into the UK's venture capital scene, growth companies, and asset management landscape. As the founder and editor, Liza leverages her extensive experience in finance and investment to empower businesses and investors with the knowledge they need to make informed decisions and drive growth.
With a career spanning over two decades in the financial sector, Liza has a wealth of experience in venture capital, asset management, and financial consulting. She has worked with a diverse range of clients, from startups to established corporations, helping them navigate the complex world of investments.