Think of the last time you made a financial decision. What are some of the factors that influenced or nudged you to act the way you did? It could be something as simple as a friend vouching for the product or you were trying to fit in with others.
These phenomena are examples of social influence — how those around us can sway our decisions and behaviors. Behavioral finance dismisses the assumption of a perfect financial analyst or investor. We are prone to errors and biases, which can be misguiding.
Types of Social Influence
Social influence involves a situation in which other people influence an individual’s attitudes, beliefs, or behaviors. There are various social influences such as conformity, obedience, compliance, social loaming, bystander effect, and peer pressure.
Most finance social influences are unconscious and caused by how we interact with our environment. Therefore, it can be difficult to know that they are affecting your decisions.
Apart from social influence, social factors can affect your financial decisions. For example, if your culture is strongly rooted in thriftiness, you may be inclined to save more and spend less. Other social factors that can influence how you make financial decisions are gender, age, and socioeconomic status.
Group Dynamics and Financial Decision Making
When you have to make an important decision, what is the first thing that you do? Chances are, you rely on the advice of people in your close circle. Making decisions within a group can be helpful because it allows for sharing different perspectives and ideas.
However, certain dynamics like groupthink can make people blindly agree with each other without any critical assessment. This can lead to greedy or FOMO investment decisions before sound analysis and reasoning.
Polarization is another dynamic that can impact financial decision-making in a group setting. When there is a strong opinion in the group, it can create an echo chamber effect. In such a case, the majority agree without considering alternatives.
We tend to compare ourselves to others, leading to poor investment decisions. Social comparison is when we compare our resources, skills, or performance with those of others. This can cause us to take on more risk than necessary to fit in or keep up with the group.
These group dynamics can lead to herd investment and momentum trading. Herd behavior is when analysts and investors follow the lead of others and invest in the same stocks or assets.
Momentum trading happens when investors buy stocks that have had a strong rally, expecting them to continue performing well. This could be fueled by fear of missing out or pressure from peers doing well with their investments.
Social Proof and Investment Decisions
Testimonials, trust icons, and reviews have become more critical when making online purchases. They give people an indication of how other customers have fared with the product and if it is worth investing in.
The concept of social proof also applies to financial decisions. We can observe what others are doing and then make an investment decision based on the evidence of success that we see in others.
This type of influencer marketing has become more powerful with the rise of social media. Trading platforms and investment advisors are using influential individuals to market their services.
Social media influencers often focus on the positive results and overlook the risks. This could be misleading when making financial decisions as there may be unseen factors behind their success that do not apply to the average investor.
Wrap-Up
How often do you stop to reflect on the impact of social influence on your financial decisions? Recognizing social influences and developing strategies to mitigate their impact is essential. Additionally, a financial advisor can guide you in making informed decisions based on sound analysis and reasoning.
