In one way or another, we all have a complex relationship with our own money. Because of this complex relationship, it is difficult to be rational all the time in how we spend and invest our money. But where do our behavioral biases come from, and what can we do to counteract them? Continue reading below as we have analyzed these questions.
What Are Behavioral Biases?
Many of us set budgets, monitor our investments and spend our money conservatively. While doing this, many of us like to think that we are acting rationally with our money. However, the truth is, people are emotional when it comes to their finances and that can affect their decision-making.
Some of the most common emotions that dictate 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.
Another common practice influenced by behavioral biases is know as emotional spending (sometimes nicknamed “retail therapy”). Emotional spending occurs when you are 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, as many people are biased toward their own money; however, you can take action to change those things that may be impacting your financial standings.
What Not to Do
One of the biggest rules in investing is avoid making rash investment decisions based on what you see in the news or hear from friends and family. Although it may be tempting, avoid making these rash decisions by doing your own research before making your own investment decision.
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. Working with a trusted financial advisor is beneficial as 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 important that you think long-term when making decisions, rather than following trends that will not be beneficial to you in the future.
One of the easiest ways to help avoid behavioral biases while spending money is to know yourself and being self-aware. This is especially important when investing as you must know your level of risk tolerance and allow that information to help determine your asset allocation strategy.
As a general rule of thumb, people who don't take on a lot of risk tend to be heavily invested in low-risk investments such as bonds, treasury notes, and dividend paying stocks and tend to see smaller return as these are considered safe investments. On the other hand, investors who take more of a risk, their portfolio is probably heavily invested in high risk investments such as stocks, and possibly cryptocurrencies. These individuals may see higher returns however, may also incur significant losses as these are high risk investments. Knowing your level of risk tolerance may help alleviate some stress regarding your investments and reduce the urge to make choices impulsively. If you are unsure about what your risk tolerance is, feel free to reach out to one of our trusted financial advisors, who can guide you in the right direction.
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. Like always feel free to reach out to one of our trusted financial advisors if you have any questions or want to further investment guidance.
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.