Behavioral Finance

Definition: The study of how our minds and emotions influence our financial decisions.

Example: The sunk cost fallacy (i.e. considering past, irrelevant costs in decisions about the future) or anchoring (basing a decision about information, even irrelevant information) are examples of thinking errors discovered and explained by behavioral finance.

Why It’s Important: Traditional classic economics assumes that we are completely rational creatures and act accordingly. Behavioral finance shows that we have consistent patterns of illogical decisions. Understanding these patterns helps us avoid them to make the best choice.

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