How Your Emotions Can Negatively Impact Your Money?-?and What to Do About?It
Eric Roberge CFP?
Financial advisor helping Boston area professionals use money as a tool to enjoy life now while also planning responsibly for the future
A version of this article was originally written for and published on Business Insider
Some of the most common money mistakes people make aren’t due to an inability to actually handle their finances.
The real trouble? Keeping the emotions around your money in check.
In theory, success as an investor comes down to logical principals. Think rationally about concrete financial strategies like asset allocation, diversification, and portfolio construction, and you should be seeing your investments grow exponentially over time with the help of compounding returns.
But investors aren’t robots. They’re people.
As Richard Thaler, a Nobel Prize-winning economist who focuses on psychology and how people make choices around money in real-world conditions, put it, “economic agents are human and economic models have to incorporate that.”
So by learning how your emotions affect your financial decisions—and how to manage that as you manage your money —you can feel more confident in both your day-to-day choices and your long-term, wealth-building decisions.?
The most common emotions that interfere with smart money management
Anxiety and fear might be the most prominent emotions that get in the way of good financial decisions. That’s understandable: money is a valuable resource in our society, and something you’ll likely always need in some amount. It’s natural to fear losing it.?
But that aversion to and fear of loss can make us do some very irrational things. It gives us tunnel vision. We lose sight of the big picture and we make short-term choices when we should be considering long-term strategy.
We forget that the stock market has rewarded long-term investors, or those who invest and stay invested over decades of time. (On the other hand, it tends to punish those who try to time the market and outsmart all other market participants.)
Fear can also make us more susceptible to recency bias—or the mindset that what is happening now is going to continue to happen into the future. Our anxiety around running out or not having enough blinds us to the fact that recessions are temporary and usually followed by periods of economic growth.
Other detrimental emotions include avoidance. Ignoring your finances altogether or thinking you’ll figure out your strategy once you’re “closer to retirement” means missing opportunities to build wealth now.
Financially successful people know their greatest advantage is time, so they don’t put important financial decisions or actions off to deal with someday. They are proactive, engaged, and motivated to properly manage their money right now—not just later.
And then there’s overconfidence. Overconfidence can blind you to the obvious and cause you to make unforced errors. When people are more confident than they should be, they are less able to accurately calculate probabilities and more likely to underestimate risk.?
Why going with your gut doesn’t work in finance
Your emotions can lead you to make mistakes… but what about trusting your gut, or listening to your intuition??
It’s likely to get you into trouble, too. That’s because of a number of cognitive biases that are designed to help our brain make quick decisions, but unfortunately, often lead us astray when we’re in the financial world.
Things like our bias toward action can cause us to make mistakes; this is the urge to do something even when the correct answer is to step back and do nothing.
This often shows up when recession fears hit new highs. We feel like we need to prepare, we need to avoid disaster, we can’t just sit there and do nothing!?
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But when it comes to your investments, tinkering with your portfolio and deviating from your set strategy can stall your progress. Or worse, selling out of your positions at the bottom of the market can cause you to lock in losses at the worst possible time.
Hindsight bias is another one that frequently trips people up when it comes to money management. It comingles with overconfidence to lead people to make major mistakes because they start thinking the right moves are obvious.?
And they are… in hindsight, after an event has happened. Hindsight bias makes us feel like the answer was obvious even before the event. We forget how we felt before we knew what we know now.
What poker player Annie Duke calls resulting can mess with our minds, too. It happens when we place too much emphasis on an outcome rather than the decision we made before we knew what happened. If we see positive outcomes, we assume it was because of a good decision (and vice versa).
Meanwhile, we discount the role of chance. We don’t remember that sometimes a good decision can still lead to a bad outcome simply because of bad luck. On the flipside, we attribute good outcomes to how smart we are, even if we made a bad decision and got lucky despite it.
How to keep emotions in check while making progress toward financial success
Financial success is always an uphill battle. But if you can lessen the noise and distraction that your own mind can generate, that will make it a little bit easier to make the right decisions and choices as you go. There are a few strategies you can use to do just that:
Set it and forget it (to a point): It’s important to spend time developing a specific, consistent investment strategy you can stick to over time. That will take some work and it’s not easy, but once you’ve gone through the process, stick with your strategy.
That means not getting caught up in current events or short-term news cycles, being distracted by what “everyone else” is doing, or letting your emotions steer you away from the path in front of you. Keep in mind that financial progress is a long-term game.
Automate what you can (like contributions to savings and investment accounts) so you don’t have to make the same decision over and over again, and aim to review (and rebalance) your investment accounts periodically but not frequently. Quarterly or semi-annually is usually sufficient.
While literally forgetting about your finances is impossible and not recommended, you don’t need to obsess daily. Doing so may be more detrimental than it is helpful.
Practice mindfulness and self-awareness: It might sound strange for a financial planner to recomend a mindfulness practice to improve your money management, but as we’ve already covered: your emotions can dictate your actions, and emotional decision-making often leads to losses.
You can’t manage your emotions if you’re drowning in them. Increasing self-awareness can help you avoid making long-term decisions based on short-term feelings.
Everyone is susceptible to various mental mistakes and behavioral biases that make even experienced investors stray from a solid, rational strategy from time to time. And while knowing something is not the same thing as practicing it in your life, you have to start somewhere.
When it comes to managing your emotions around money, that starting point is awareness of what's going on in your head—and where you are most likely to fall victim to your own psychology. Know your weak spots, and you’re more likely to steer confidently around them.
Work with a professional: Part of the value of working with a professional financial planner is in having an objective third party with an outside-looking-in perspective.
An advisor can provide you with technical know-how and strategies to use, and act as a sounding board, a second opinion, another set of eyes to check your blind spots, devil’s advocate when you need to think through complex decisions, and more.
A good advisor doesn’t just give advice. They ask the right questions to help you understand what you want and why.
Then they help you build a specific financial plan to get to those unique goals and outcomes, keeping you on track and avoiding mistakes along the way as you progress forward.
If you’re ready to optimize your financial life and enjoy the confidence that comes with knowing you’re making all the right moves to grow wealth and increase your assets,?start here.