Paul Tarins, RICP®,WMCP®,CSRIC™
The relationship between a person and their money is an intricate and complex one. You want it to be calculated and rational, but the truth is that sometimes, our judgment is sometimes clouded by irrational factors. We all occasionally make financial decisions that are motivated by something other than pure logic.
The ways you choose to use your money can be attributed to what are called behavioral biases. Behavioral biases are when you tend to always think and move in a certain way, or according to a specific principle. Constantly giving in to these biases can hold you back financially, and that’s why it’s good to be aware of them.
Today we’re going to explore what financial biases are, what you need to avoid with them, and what you can do to make sure your biases aren’t getting in between you and prosperity.
What Are Financial 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:
You’ll note that some of these are negative emotions, and some of them are positive ones. Any kind of feeling that takes hold of you can influence how you choose to spend and invest. You might invest heavily in gold out of anxiety about the U.S. dollar losing value, or you might invest a lot into a shiny new startup that you hear about out of optimism and hope that it’ll be the next big thing. 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).
Fear, hope, it doesn’t matter. At the end of the day, what does matter is that you be aware of what’s influencing your fiscal decisions. If you’re making big decisions on impulse, without considering the ramifications, you are potentially putting your financial future at risk.
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. It’s getting bad press, so won’t the company soon be on the downward spiral?
In reality, this indiscretion 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, by dumping your stocks based on one news cycle, you made an in-the-moment decision that could potentially harm you financially.
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.
It’s tricky! We can’t always predict what’s going to come up down the road, and sometimes respond reflexively to what we see happening around us. You want to be careful, but not so cautious that it stunts your long-term growth. Navigating the financial world requires a lot of thought and care.
But that’s just it—you have to think your decisions through, not simply make them on whims.
What Can You Do Instead?
So, maybe you’re starting to think about being more self-aware about your decision making. Perhaps you’re going to start looking before you leap, and examining situations from multiple angles. Here are a few things you can do to make sure you’re crafting the best financial decisions for your situation.
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. This will help you to maintain financial stability now, and to develop a plan as you begin to search for retirement solutions.
Examples of financial professionals with whom you could consult include:
- An accountant
- A financial planner
- An attorney
- An investment advisor
- A debt counselor
- A money coach
Each of these types of experts can help you in different ways, but they all have in common one thing: they are professionals, and they might be able to help you to more deftly navigate the world of your finances.
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. For example, rather than buying a stock simply because it’s popular, look into more of your options and attempt to determine what’s really going to pay off for you as the years go by.
It’s not enough to be on the lookout for a quick windfall; sometimes, these situations take a while to develop into all that they’re destined to be. You have to be cognizant of the greater ramifications that can spread from your decisions. Don’t be too hasty!
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 developing control over your ingrained behavioral biases will help you as you attempt to create your ideal life, from now all the way through your retirement. Whether you choose to bring in the help of a professional financial advisor, or decide to simply do some reflecting and develop a greater self-awareness, by taking these steps, you’re actively making choices to better your financial present and future.
Don’t wait. Start thinking today about what you can do to make sure your decisions aren’t being unduly impacted by your emotional biases.
Paul Tarins is an investment adviser representative of and offers investment and advisory services through Portfolio Medics, a registered investment adviser. Nothing contained herein should be construed as a solicitation for investment advisory services. Sovereign Retirement Solutions and Portfolio Medics are not affiliated.