Behavioural finance: explaining the link between emotions and savings

Do you remember the first time you thought about saving and investing your money?

But above all, do you remember what you did to start finding out information about it?

I’m pretty sure that before you did anything else, you Googled “How to save” and “How to invest”. The reason I’m pretty sure of this is because they are among the first search results of Google’s auto completion suggestions (try it yourself!).

Among the articles you found there would most certainly have been a range, between those which were far too technical to understand, and those which were just ‘fluff’. There would also have probably been articles that suggested ‘one step fits all’ books, and the ones that reported the author’s experience; who changed his life with his own unique savings method and now simply enjoys life.

Taking into account only the useful and well written articles - those which contained valid and judicious advice - you probably started putting together a little vade mecum of rules; rules that belonged uniquely to you, and that made sense to your ‘savings journey’.

There is a ‘but’ in this story though, as, since then, I bet that for some reason you haven’t been able to faithfully follow those simple and basic rules you created for yourself. You've got confused, you've made mistakes, and maybe you’ve even lost money.

You may have blamed the stock market, consultants, Santa Claus…but, at the end of the day, you aren’t sure who’s responsible.

I’m here to tell you: it’s you, as a human being, carrier of emotions.

‘Too human’ savers    

Follow me for a moment and let me steer you into classical economic theory: if each of us were homo oeconomicus, as opposed to mere homo sapiens, then ideally we would take decisions about our money only after:

·       Having consulted all the possible financially informative material, including not only the saving method we want to pursue but also all possible alternatives (completeness of information);

·       Having examined and assured ourselves that the information is reliable (accuracy of information);

·       Having investigated all the possible outcomes of our choice (capacity to predict all possible scenarios);

·       Having thought about it and approached the situation with rationality and common sense (lack of emotion).

From this brief explanation you’ll no doubt reach the conclusion that to become a member of homo oeconomicus is as likely as sprouting a beard and becoming Santa Claus.

Fast and slow thoughts  

I can see you now with your head in your hands, telling yourself that in view of all of this, it’s impossible for you to invest and save cleverly. You are, after all, a mere human being and it’s impossible to eliminate these faults and to hold off the emotions which lead you astray.

However, as always, there’s a ray of hope: the more you know of the social and psychological mechanisms which rule your relationship with money, the better you can recognise and avoid the most common pitfalls.

This is where “Behavioural finance” comes to our aid. Although it is a long studied discipline, in recent years it has had somewhat of a surge into the limelight. It is a system that helps us understand the way in which our mind works when it comes to money and finance.

You can see it as a branch of economic and financial studies, which integrates psychological, individual, and social aspects to explain the real behaviour of the stock market and its actors (ie. all of us, savers and investors).

Daniel Kahneman, Israeli psychologist and winner of the Nobel Prize for Economy, is considered one of the founding fathers of Behavioural finance: together with psychologist Amos Tversky he demonstrated, with several experiments, that our decisional processes often violate the principles of rationality.

If you are looking for a good essay to discover more about these fascinating mechanisms and you aren’t afraid of a lengthy and complex read, you can read “Thinking, fast and slow”.

Our trip among the fascinating mechanisms of our mind, to start understanding more and saving and investing better, has only just begun!

Oval Money, with its savings accumulation mechanism, can be a great help in holding off emotions when it comes to making rational choices about your money!  

More from Financial education