In this six part series, we’ll uncover not only what is behavioral finance, which we’ll go through in this video, but we’ll also talk about those biases. Specifically, what are those biases that make up cognitive biases and emotional biases that lead us astray and lead us to make not the best decisions that we could make. Now, this is critical information for syndicators and funds, because we’re buying assets for our investors in order for them to make money. But everybody has these underneath the surface. And once we can identify that, hey, these are what they are, it will make us better investors, because we can either mitigate them, or learn to deal with them and find workarounds. So they don’t pose a problem to ourselves, and ultimately, our investors.
I know you’re gonna like this six part series on behavioral finance, it is very important to know because it’s going to make you as a syndicator, or a fund manager, understand how to make better decisions, when it comes to choosing what assets to buy, when to exit all those decisions that you have to make to make money for yourself and for your investors. So let’s go through from a higher level, what is behavioral finance? Now, I said in the beginning introduction that evolved in the 1990s. So what happened was this, we have a world that we could call the Orthodox financial world.
In that orthodox financial world, there was a process or a way that we looked at finance, it started with the premise that all individuals are rational. That idea that all individuals are rational, and that finance itself was a rational process in order to make money. So risks were assessed and thought about and waited and scored and figured out what made the most sense, right, it was a very, you could basically put it all into a calculator, at the end of the day, a number would be spit out of not only how much money you should invest, but what sort of return you should get. This still goes on today. And it’s still extremely important. It’s part of our financial modelling that we do, whenever we do financial analysis for any kind of property or any kind of asset that we’re going to be buying, on behalf of our investors are selling, it’s part of the underwriting process for us to go behind. So it’s still very present. But it starts with this notion that everything that goes on here is a rational process. So out of this rational process, we use all relevant info to make decisions.
Right, we’re very rational people, we use all the information at hand in order to do it part of that due diligence, making sure we understand what all those risks are, we can score those risks, we can come up with scenarios and do scenario analysis and Monte Carlo simulations to make sure we understand at the end of the day, what our risk levels are, and that the likelihood of success of returning this and getting a real value for our investors and for ourselves. Right, that’s, that’s part of the original way of thinking. So we’re still doing that again today, right? So we still we still do that. And out of this comes efficient markets.
So that was the idea of that everything in the marketplace is efficient. So the pricing comes together by buyers and sellers all with all the information, making rational decisions. And so the outcomes were basically predetermined. You know, there were things that were already Oh, that would happen and move the numbers, but everybody would always agree on what actually something was worth and what you’d pay for it. Well In the 90s, people started saying, that’s not what we see at all. We see people who are paying crazy prices for things, we see people that are not spending money for things that are great opportunities, what is going on here, we also see people who are not who are so afraid of, of selling at at a at the wrong time, that they’ll stay in long after long after something is done, putting good money after bad after bad after bad. Keep investing that money to keep that decision if you’re making a flow. Now, why does that happen? If we’re all rational? Well, it doesn’t, it doesn’t happen. And so this is the idea that, Oh, maybe this orthodox idea is fine for an ideal, right? It’s a good starting place for what we should aspire to, and how we should come up with things. But it also isn’t real. It isn’t real in the sense that it’s not actually what we see happening. What we see happening instead, is behavioral. Is that out of these things? There are major psychological factors at play. Psychological factors are changing our minds. They’re the lens that we’re looking at, for through the Orthodox things, but we’re still making decisions. And we’re still trying to analyze, and that’s influencing the numbers. And this is what explains those anomalies. Right? Is that the psychological factors that are coming into play? Or would explain it? That’s why things are sometimes you have crazy prices on things that make no sense at all. I mean, I’m sure you know, of assets that just don’t make any sense. Maybe it’s your favorite stock. It’s like, how on earth could that be trading in 1000 times earnings? Or does it even have earnings, and it’s trading so much? And it’s such a terrible idea? Well, psychological factors are the what are what’s at play here. And behavioral finance is shifting those things. Right. So behavioral finance is, is accepting that individuals behave irrationally. Not all the time, obviously. But they do have a tendency to behave rationally, we make decisions very quickly, sometimes that are snap decisions that are terrible. Sometimes they work out, sometimes not. And that, to do that, individuals we use rules of thumb.
Or heuristics and shortcuts. I don’t think you’ll find a human being on the planet who doesn’t, you know, it’s so accepted. Behavioral Finance is real. So that’s what behave, how behavioral finance kind of came to be a recognition that there are things happening that are completely unexplainable outside in within the by Orthodox, the Orthodox financial models that we have, behavioral has to be playing bar, and you’ve seen this in your everyday life. So there are actually two kinds of biases we have cognitive and we have emotional so these are two different sets of biases that we know that we have, and then what we can look at through this lens of behavioral finance. So this is what came out of it is that we have these different ones. And when I now in this video, we’re just going to talk about what those two are kind of compare and contrast. In the next videos we’re going to go through in detail the different actual biases that exist. So I know you’ll find these useful. Cognitive cognitive biases are caused by faulty reasoning. So it’s us trying to be rational and reason things out. But mistakes happen. And so that could be mistakes, interest processing whatever it is that we’re doing, right, or it could be memory errors remembering things wrong incorrectly, or a lack of understanding.
Have topics like statistics right can lead us astray? So it’s just faulty reasoning. The idea was good. We wanted to be we wanted to make things in a rational way. But there was just a myth. The machine wasn’t working quite well, quite right. It made a mistake. So that’s the that’s just a faulty reasoning problem. It’s a cognitive problem. Now, these can be mitigated. Through education, advice, and information.
Right? Because if they’re just cognitive problems, if it’s just the reasoning, it was broken, in some some manner, the logic that we were applying was just made, who there was an error in, that can be solved? Right? I mean, it’s just part of it. It’s a very formulaic thing. It’s it can be solved. But what’s different is emotional. Right? So these are caused by impulse, or intuition. So there are mistakes that we make because we’re acting impulsively, or we’re just relying on intuition. They’re spontaneous. They’re due to feelings, or attitudes that we have about certain things. There are ways for us to decrease the pain and increase the pleasure. Now, how do we mitigate this? I don’t know. The best way we can do is to recognize that we’ve got these emotional biases going on. And if we can recognize that they’re going on, we can adapt ourselves to them and change our processes in order to diminish the effects of them to make the the negative effects that are there go on, also gives us an opportunity to question them to say, Well, why am I thinking this way? Why am I choosing to be impulsive and make this this kind of decision, because maybe that’s something that needs to be checked on a much higher level, and fixed. So in this net in these next videos, so five videos after this one, in this six part series, we’re gonna go through those each individual biases, we’re gonna go talk about what the cognitive biases are. Well, then we’re going to talk about what those emotional biases are, and then figure out what can we do about them. So I know you’re gonna find these videos helpful. I’m very excited to get to present this information to you because I know it’s going to make you a better syndicator it’s going to make you a better fund manager. It’s going to give your investors more money may make sure that they’re that what they’re ultimately investing into is better quality. It’s relying on what your magic is, because your magic isn’t in making spontaneous and impulsive decisions. Your magic that you’re bringing to the table is the opportunities for them to invest in things that go through your proper reasoning that you’ve thought about, that you’ve come to the right conclusion that match up with your founder investment theory and make them money and make you money at the same time. My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group.