What Are Behavioral Biases & How Do They Affect Your Money?
We all have a complex relationship with our own money, in one way or another. Because of that fact, it is sometimes hard to be rational in how we use our money. Where do our behavioral biases come from, and what can we do to counteract them? Let’s explore these questions below.
Behavioral Biases
Many of us pay attention to our finances by setting budgets, regularly monitoring our investment accounts and spending our money conservatively. Because of these behaviors, many of us like to think that we are acting rationally with our money. But the truth is, most people are emotional when it comes to their finances and that can negatively affect their decision-making.
Common emotions that will influence how we spend and invest our money include:
- Fear
- Guilt
- Shame
- Envy
- Hope
- Excitement
In terms of investments and retirement accounts, these emotions could lead to making decisions that impact your portfolio in the long run. As an example, you may choose to “follow the crowd” due to fear of missing out or decide to sell shares impulsively when stocks begin to trend down.
Emotional spending (aptly nicknamed “retail therapy”) is a common practice heavily influenced by behavioral biases. When you’re unhappy or upset, buying something new will often times make you feel better (at least for a little while).
You are not alone in your behavioral biases, and you can take action to change those things that may be impacting your financial standings.
Stop Yourself
While it may be tempting, try to avoid making rash investment decisions based on what you see in the news, read on the internet, or hear from friends and family.
For example, you could hear that a CEO of a major corporation is stepping down because of an allegation of fraud against him. After hearing this news, your first reaction may be to sell your stock in that company. In reality, this allegation may have no impact on the company’s overall performance - especially in the long run. Instead of considering the company’s stock and how it may perform over the span of years or even decades, you made an in-the-moment decision based on short-term changes. It is understandable that your gut reaction was to protect your assets in the moment, when in reality you may have actually hurt your chances for greater returns down the line.
What Should You Do?
Speak With A Professional
If you find that your spending and the way you manage investments tends to be dictated by your emotions, you ought to consider working with a financial advisor. He or she will be able to act as an unbiased third party to assist you with investment decisions and other aspects of your financial life.
Look Long-Term
It is imperative that you think long-term when making financial decisions, rather than following trends that will not always be beneficial to you in the future.
Look In The Mirror
Being self-aware is an important step in avoiding behavioral biases when it comes to investing your money. Be aware of your level of risk tolerance and let that information help determine your asset allocation strategy. Being invested properly will help alleviate some worry regarding your investments and should reduce the urge to make choices impulsively.
Acknowledging and keeping your behavioral biases under control can help you feel confident in your investment decisions and everyday spending choices. Seek out a trustworthy financial advisor to have an objective third-party available to offer you educated guidance and direction - without emotional bias.