In one way or another, we all have a complex relationship with our own money. Because of that, it’s hard to be rational all the time in how we use it. 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:
In terms of investments, this 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.
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?
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. He or she will be able to act as an educated, unbiased third party to guide you through investment decisions and other aspects of your financial life.
It is also vital that you think long-term when making decisions, rather than following trends that will not be beneficial to you in the future.
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.
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.