Finance. When the average person hears the word finance, they have no idea that there are different types of finance. Behavioral finance and traditional finance are substantial aspects of finance. For instance, behavioral and traditional finance influence the decision to invest in stocks. Although they both impact stocks, there are significant differences between them.
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The link above is more recently updated and contains all of the information you need to know about the differences between behavioral and traditional finance.
Differences Between Behavioral Finance and Traditional Finance
What is Behavioral Finance?
Psychology plays a vital role in behavioral finance because it determines how people make financial decisions. Behavioral finance takes real-world examples into account and states that people tend to make investment decisions emotionally rather than rationally.
These emotional factors include long-term trust in the organization, friends' advice, family's advice, etc.
For example, many athletes will always purchase sports products from Nike because of their past experiences with Nike. These athletes trust Nike, as he or she has always bought products from them.
Due to this immense trust, these athletes only emotionally think about where to purchase their products from.
This shows that the bias of past experiences inclines one to invest more in a particular company.
These emotional factors include long-term trust in the organization, friends' advice, family's advice, etc.
For example, many athletes will always purchase sports products from Nike because of their past experiences with Nike. These athletes trust Nike, as he or she has always bought products from them.
Due to this immense trust, these athletes only emotionally think about where to purchase their products from.
This shows that the bias of past experiences inclines one to invest more in a particular company.
(Zeeshaan)
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What is Traditional Finance?
Meanwhile, in traditional finance, investors are practical, and they make decisions based on mathematical calculations, economic models, market behavior, and other types of data. In other words, investors and consumers comprehend information unbiasedly, allowing them to decide scrupulously.
In the previous scenario, if Adidas were to offer the same products but a lower price than Nike, many athletes would start buying their products from Adidas. These athletes made their decision about which product to invest in rationally rather than emotionally. Their financial decision was made rationally, for they noticed that the statistics/data show that purchasing from Adidas proves to be more financially rewarding.
This is exactly what traditional finance suggests: that people make decisions based on statistics.
In the previous scenario, if Adidas were to offer the same products but a lower price than Nike, many athletes would start buying their products from Adidas. These athletes made their decision about which product to invest in rationally rather than emotionally. Their financial decision was made rationally, for they noticed that the statistics/data show that purchasing from Adidas proves to be more financially rewarding.
This is exactly what traditional finance suggests: that people make decisions based on statistics.
Why Do Behavioral and Traditional Finance Differ?
The difference between the two concepts occurs because in traditional finance, investors consistently gain knowledge, data, and various immaculate information. Since investors are able to apprehend the market precisely, their financial actions are exceptionally scrupulous.
However, unanimously, we can all agree that no one possesses flawless information, and this is what behavioral finance is based on.
Behavioral finance states that it is impossible for people to process all information, implying that they do not act entirely rationally.
Given that somehow the information is impeccable, people would still make an error in judgment. As we all know, people are not perfect.
In the real world, traditional finance asserts that self-control causes the market to be perfect and efficient.
Contrarily, behavioral finance believes that emotions cause the market to be unpredictable and imperfect, resulting in market anomalies. Since emotions tend to alter constantly, it has a direct impact on the market.
For instance, we see the stock market fluctuating so much; some stocks’ value sky-rockets, while others’ value plummets.
Behavioral finance also suggests that people’s decisions are greatly influenced by friends, family, socializing, self-understanding, tradition, and heuristics.
Think about it. You will most likely buy the products that all your friends own, regardless of how much better another product is.
All these emotion-related factors cause one to deviate from rational decision-making.
However, unanimously, we can all agree that no one possesses flawless information, and this is what behavioral finance is based on.
Behavioral finance states that it is impossible for people to process all information, implying that they do not act entirely rationally.
Given that somehow the information is impeccable, people would still make an error in judgment. As we all know, people are not perfect.
In the real world, traditional finance asserts that self-control causes the market to be perfect and efficient.
Contrarily, behavioral finance believes that emotions cause the market to be unpredictable and imperfect, resulting in market anomalies. Since emotions tend to alter constantly, it has a direct impact on the market.
For instance, we see the stock market fluctuating so much; some stocks’ value sky-rockets, while others’ value plummets.
Behavioral finance also suggests that people’s decisions are greatly influenced by friends, family, socializing, self-understanding, tradition, and heuristics.
Think about it. You will most likely buy the products that all your friends own, regardless of how much better another product is.
All these emotion-related factors cause one to deviate from rational decision-making.
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Summarizing
You can conclude that traditional and behavioral finance differ eminently because behavioral finance advocates emotional decision-making, while traditional finance advocates rational decision-making.
Nevertheless, traditional finance and behavioral finance are both imperative to understanding markets and the economy. Traditional finance puts forth expectations for the market and its investors; whereas, behavioral finance puts reality forward.
For a more complete article, go to the following link: fmearticles.com/traditional-vs-behavioral-finance-the-key-differences/
Nevertheless, traditional finance and behavioral finance are both imperative to understanding markets and the economy. Traditional finance puts forth expectations for the market and its investors; whereas, behavioral finance puts reality forward.
For a more complete article, go to the following link: fmearticles.com/traditional-vs-behavioral-finance-the-key-differences/
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Works Cited
Marr, Bernard. “The 6 Biggest Technology Trends In Accounting And Finance.” Forbes, Forbes Magazine, 27 July 2020, 12:23AM EDT.
Reporter, Herald. “The Difference Between Traditional Finance and Behavioral Finance.” University Herald, 3 Feb. 2020,11:32 AM.
Zeeshaan. “Behavioral Finance V/s Traditional Finance.” Medium, Medium, 22 Aug. 2020, medium.com/@zeeshaan2696.
Reporter, Herald. “The Difference Between Traditional Finance and Behavioral Finance.” University Herald, 3 Feb. 2020,11:32 AM.
Zeeshaan. “Behavioral Finance V/s Traditional Finance.” Medium, Medium, 22 Aug. 2020, medium.com/@zeeshaan2696.