While we may not consciously realize it, we all have a complex relationship with our own money. As a result, 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?
Have you ever driven on the freeway and notice how everyone is driving crazy while you seemingly are the only sane person on the road? All the while not noticing that you are also speeding well past the speed limit? On the other hand, you might think you're a lousy driver but you have never received a traffic violation in your life. It's the same thing with money. Some of us think we are great with money but we have a mountain of debt. Others think they will never save enough no matter how much money they have in the bank. We like to think that for the most part we are acting rationally with our money. But the truth is, we are emotional when it comes to our finances and that can affect our decision-making.
Common emotions that influence how we spend and invest include:
In terms of investments, this could lead to decisions that impact our portfolio in the long run. For example, we may choose to “follow the crowd” and blindly invest in cryptocurrency due to fear of missing out. We know how that turned out. We might have sold all of our shares of stock when Markets fell in 2020 during Covid but missed out on the eventual Market rebound. Or as a result of negative financial articles that we've read, decide that we will keep our money safely in cash because we are worried that this time, the financial markets will melt down.
We all know about eating disorders but there are also spending disorders. This can be mild or extreme. Spending disorders occur when we use money to fill an emotional void. When we are unhappy or upset, buying something new can make us feel better (at least for a little while). Spending disorders leads to impulsive spending, credit card debt, and in extreme cases bankruptcy.
There are also behavioral biases that limits our ability to spend money and enjoy our lives. We might have come from a challenging background as children but through luck, perseverance, and hard work have built up a sizable investment nest egg. However, whether through guilt, shame, or fear, we cannot allow ourselves to spend money and enjoy the fruits of our labor. We either feel we don't deserve our wealth, are afraid we will lose it, or ashamed to have money while others do not.
We are not alone in our behavioral biases, and we can take action to change those things that may be impacting our financial situation.
What Not to Do
Although it may be tempting, we should avoid making rash investment decisions based on what we see in the news or hear from friends and family. In other words, we have to tune out all of the noise around us and stay disciplined.
For example, we may hear that a CEO of a major corporation is stepping down because of a fraud allegation against him. In turn, our first reaction may be to get rid of our 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, we made an in-the-moment decision based on short-term changes. Our gut reaction was to protect our assets right now, when in reality we may have actually hurt our chances for greater investment returns in the future.
What Can You Do Instead?
Partner with me, your Financial Advisor
Planning your future spending and managing investments on your own is stressful and can be difficult. Furthermore if you tend to be dictated by your emotions than staying disciplined can and will be a challenge. One of the main benefits of working with me, is that we have meaningful money discussions so that you can feel confident that you are making the best financial decision. I help you think through your money decisions and uncover any behavioral bias that might be influencing your investing or spending decisions.
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. Working together, we create and implement a financial investment strategy that is built on a sound rational foundation rather than on investment noise and the emotions of the day.
"To know thyself is the beginning of wisdom" - Socrates.
Being self-aware is an important step in avoiding behavioral biases when it comes to investing and spending. Think about the money challenges that you are currently experiencing. What behavioral biases do you think can be contributing to these challenges and how can you remove them?
Remind yourself that successful long-term investment results are built on rational decision making without the distraction of emotions. When making money decisions, ask yourself if you are being rational or irrational? If you feel you are being irrational, dig deeper to uncover the biases that is causing your irrational behavior.
If you are the type of person who know your emotions can get the better of you, delegate the day to day managing of your investments to a financial advisor like myself. The removal of emotions is one of the main reasons why people decide to delegate investment management to financial professionals.
Be clear as to what your long term goals are, the financial resources necessary to achieve these goals, and your tolerance for investment risk. Allow that information to help determine your long term investment and 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 me, your trusted financial advisor allows an objective third-party to offer educated guidance, direction, and execution - without emotional bias.
This content is developed from sources believed to be providing accurate information, and provided by Twenty over Ten and Attune Financial Planning. 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 only.