Almost everyone has a complicated relationship with money. Strong emotions are common, yet they even more frequently stand in the way of sound logic. Truthfully, it’s difficult to be rational all the time when managing money. Behavioral biases impact nearly every decision you make, whether you notice them or not. But where do our behavioral biases come from, and what can we do to counteract them? We explore these questions below.
What Are Behavioral Biases?
Many of us set budgets, monitor our investments, and spend conservatively. In doing so, many of us like to think that we are acting rationally with our money. But the truth is, people are emotional when it comes to their finances and that can affect their decision-making.
Common emotions that influence how we spend and invest include:
Excitement — Happiness can lead to a false sense of optimism and spending to “celebrate”. This optimism could lead you to go all-in on investments that aren’t logically sound, only to regret them later.
Anger — When you’re extremely angry, you’re prone to make rash financial decisions. While you may feel satisfaction immediately after making a purchase, it isn’t likely to last. Always wait until you’ve calmed down.
Anxiety — We all get worried sometimes and fearing you’ll lose your life savings is definitely cause for concern. Anxiety could lead you to divest before you’ve seen value, causing you to miss out on good opportunities, and otherwise not think clearly.
Jealousy — When your neighbor pulls in with their fresh-off-the-lot new car or brags about having thousands in Bitcoin, do you feel tempted to make purchases to catch up? “Keeping up with the Joneses” can leave you in massive debt with assets you don’t even care about.
In terms of investments, these emotional biases could lead to decisions that impact your portfolio in the long run. For example, you may choose to “follow the crowd” due to fear of missing out or sell shares impulsively when stocks start trending down.
Emotional spending (sometimes nicknamed “retail therapy”) is another common practice influenced by behavioral biases. When you’re unhappy or upset, buying something new can make you feel better (at least for a little while). You’re not alone in your behavioral biases, and you can take action to change those things that may be impacting your financial standings.
What Not to Do
Although it may be tempting, avoid making rash investment decisions based on what you see in the news or hear from friends and family. Try not to make big changes or purchases when your emotions are running high.
For example, you may hear that a CEO of a major corporation is stepping down because of a fraud allegation against him. In turn, your first reaction may be to get rid of your stock in that company. When in reality, this may not have any impact on the company’s performance - especially in the long run. Instead of thinking about that company’s stock over the span of years or decades, you made an in-the-moment decision based on short-term changes. Your gut reaction was to protect your assets right now, when in reality you may have actually hurt your chances for greater returns down the line.
What Can You Do Instead?
Understanding that you have behavioral biases and making an effort to minimize their impact on your spending is important.
Instead of following today’s trends or making decisions fueled by temporary emotions, it’s vital that you think long-term when making decisions. Always keep your end goal in mind. If you’re focused on saving for a retirement you can enjoy, it will be easier for you to skip envy-fueled frivolous spending.
Being self-aware is an important step in avoiding behavioral biases when it comes to investing. Know your level of risk tolerance and allow that information to help determine your asset allocation strategy. Doing so should help alleviate some worry regarding your investments and reduce the urge to make choices impulsively.
Talk to a Professional
If you know that planning your future spending and managing investments tends to be dictated by your emotions, consider working with a financial advisor. They will be able to act as an educated, unbiased third party to guide you through investment decisions and other aspects of your financial life.
Acknowledging and controlling your behavioral biases can help you feel confident in your investment decisions and everyday spending choices. Working with a trusted financial advisor allows an objective third party to offer educated guidance and direction - without emotional bias.
Schedule time to talk to one of our financial advisors about your retirement plan today.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.