Making financial decisions in real life: deviating from financial theories

M.K. Lai

Finance practitioners and investors and have to make financial decisions that may involve their own, their clients’ or their companies’ money, on a day-to-day basis. M.K. Lai’s e-Series on behavioural finance will help CPAs to understand how people’s behavioural aspects may compromise the quality of their financial decisions

Many accountants learn financial theories at some point in their career. However, most of them may not be aware that there are a number of implicit assumptions behind these theories. For example, they may not know that rational human beings – those who receive information and are able to interpret it without bias – are only concerned about the investment characteristics of risk and return, and are likely risk-averse. 

Judging from the personal experience of an accountant, however, these assumptions are unrealistic and invalid when real-life financial decisions are involved. In reality, human beings are often irrational and sometimes impulsive. Impulsive shoppers, for instance, don’t intend on buying anything upon entering a department store, but will always end up purchasing something before leaving.

Different people may also receive different sets of information, which is known as information asymmetry. For example, corporate directors and managers know more about the quality of their own companies than outside investors. Obviously, people can only make financial decisions based on the information they receive.

Human beings may not have the ability to fully assimilate and interpret the information they obtain, and they are susceptible to a number of behavioural biases when making financial decisions. For example, one’s source of income may affect risk attitude. If one earns their income through hard work, that individual might be more conservative when it comes to making investment decisions.

People not only care about the risk and return of an investment, but can also be affected by their religious beliefs, environmental, social and governance issues and social responsibilities. That is why Islamic bonds, green funds and socially responsible funds exist in financial markets.

Human beings can also be both risk-seeking and risk-averse at the same time, which might explain why they buy lottery tickets on the one hand and purchase insurance policies on the other.

Behavioural finance is a budding field that seeks to explain how people actually make financial decisions from a psychological perspective and other behavioural disciplines. My courses try to provide a systematic way for accountants to understand the complexity and subtleties in how people make real-life financial decisions.

About the courses 

In the e-Series course “Investment Biases that Every Accountant Should Know,” participants learn about the investment biases that are most likely exhibited by Hong Kong investors. Furthermore, they learn how to apply behavioural finance concepts in different finance areas including investment, wealth management, and corporate finance.

In the e-Series course “Personal Risk Profiling that Every Accountant Should Know,” the focus is on the application of behavioural finance in personal risk profiling, which is a very important step in wealth management. The objective of personal risk profiling is to determine the risk tolerance of a client. In practice, it is achieved through a risk profile questionnaire and structured interviews. Behavioural finance can help us to understand the different dimensions of risk profiling in a more enlightened manner.

Behavioural corporate finance is a field that explores the behavioural aspects that compromise corporate directors and managers from making optimal corporate financial decisions, such as financing, investments, mergers and acquisitions, payout policies, working capital management and financial risk management.

The central theme of these courses is to help participants understand that when people make financial decisions, they are susceptible to many behavioural factors and hidden agendas, which are otherwise not discussed in financial theories. Accountants must broaden their horizons and open up their minds to these subtleties if they want to understand how corporate managers and investors make financial decisions in the real world. Above all, it is an important way for accountants to add value to and improve the quality of their financial decisions with respect to their employers or their own investments.

Members can enrol in both e-Series courses on the Institute’s website.

M.K. Lai is the Principal Consultant of Executive Training and Management Consultancy Company Limited. He has been offering quality training and consulting services to a wide variety of financial institutions, academic organizations and professional bodies for more than 20 years. He obtained a doctorate degree in finance from the London Business School. He is a CFA Charterholder. He has also published four professional books, a number of study manuals for professional bodies’ examinations.

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