By: Mercy Kano, Doctoral Fellow SIMS
Investing is not just about numbers and charts; it has a lot to do with human psychology. Behavioural finance explores the influence of psychological factors on financial decisions. While traditional finance assumes that people make rational decisions at all times, behavioural finance recognizes that emotion and cognitive biases are likely to lead to less-than-perfect choices.
Some key concepts in behavioural finance include emotions, loss aversion, and cognitive biases. Emotions like fear or excitement could affect investment choices, for instance, selling stocks prematurely during market downturns out of fear. Loss aversion is the tendency to fear losses more than valuing gains, leading to overly cautious investments in low-risk options like government securities. Cognitive biases include familiarity bias (favouring familiar investments), herd behaviour (following the crowd), overconfidence (assuming one can accurately predict market movements), status quo bias (preferring to maintain things the way they are), and anchoring bias (overreliance on initial information), among others.
In Kenya, where many people are not familiar with stock investments and other financial securities, the psychology of investing drives people to invest in physical assets like property, businesses, and government bonds, which are seen as relatively safe. Kenyans are culturally inclined toward investments they can touch or see, like real estate, as a symbol of security and prosperity. But this reliance can lead to missed opportunities in other financial assets. Herd behaviour tends to lead people to imitate friends, relatives, or follow current trends. The 2024 Finaccess Household Survey Report highlighted that friends and family were a significant source of financial advice for most respondents. This behaviour can inadvertently create bubbles in sectors like property, where prices do not always reflect true value. For instance, Nairobi has seen a surge in real estate prices in recent years, arguably driven by herd behaviour. This situation is compounded by overconfidence in real estate investments due to perceived high returns, leading to the belief that property values always rise. This belief often overlooks the accompanying risks, such as decreased liquidity or unexpected maintenance costs.
Diversifying investments across stocks, mutual funds, unit trusts, and other assets can help to manage psychological influences on choices. Furthermore, proactive learning through seminars, financial advisors, and trusted resources can help reduce skepticism about investing in the stock market and other financial assets.
In summary, by having an idea of the psychological factors that come into play in making investment decisions, people are better equipped to make more informed decisions in line with their own financial goals—be it investing in a farm, a business, a plot of land, or the stock market. The best investment strategy is one that is well-researched, diversified, and aligned with long-term objectives.
