Consumption and Investment Decisions from Behavioral Finance Perspective

This review paper examines the role of behavioral finance in understanding irrational consumption and investment decisions, which traditional financial theories often fail to explain. By integrating psychological principles with economic models, behavioral finance reveals how cognitive biases—such as loss aversion, overconfidence, and mental accounting — systematically influence financial behavior. The study synthesizes key findings from experimental and empirical research, demonstrating that investors frequently deviate from rationality due to emotional and social factors. For instance, loss aversion leads to risk-averse behavior in gains but risk-seeking in losses, while overconfidence results in excessive trading and under-diversification. In consumption, present bias and framing effects often drive impulsive spending and poor savings habits. The paper also discusses practical implications, including improved financial product design, policy interventions like automatic enrollment in pension plans, and personalized financial advice to mitigate biases. By bridging psychology and finance, this research enhances theoretical frameworks and offers actionable strategies to promote rational decision-making, ultimately contributing to more efficient markets and better individual financial outcomes.