The emotions that drive our financial decisions are just as important as the logic and reason we use to make monetary choices. When we understand the role psychology plays in the overall financial planning and wealth management process, we tend to make better decisions about our money. For example, when it comes to your finances, financial anxiety and/or financial biases have a significant impact on your decision-making process.
Financial Anxiety
The anxiety associated with managing your money can be brought on by a lack of understanding or the feeling of being unprepared. Everyone worries about money at one time or another but a constant feeling of stress about your finances may manifest itself as financial anxiety.
You are more likely to feel stressed about money if you find yourself in the following situations:
• Lacking funds to cover everyday expenses or pay down debts is one of the most common reasons to stress out about money. Inflation has had a major impact on personal finances over the past year.
• You feel social pressure to keep up with the Jones’s. The feeling of not earning or having enough is fueled by unrealistic societal expectations and can lead to impulse buying and overspending.
• You’re mentally and emotionally unprepared for retirement. Switching from accumulation to decumulation of your investments in retirement is a major life change that can cause a feeling of disempowerment and a fear of running out of money.
• Holding excessive credit card or loan debt can be a major source of stress. A recent Forbes Advisor survey found that 66% of respondents say they would be very or somewhat likely to consider bankruptcy to address their debt situation.
Financial Bias
Biases stem from our upbringing, education, and our environment. They cause us to lean in one direction towards or against something. Biases can be conscious or unconscious as well as cognitive or emotional. There are several types of financial behavioral biases that can impact an investor’s decision making. Let’s look at a few.
Overconfidence (emotional) – Studies show that overconfidence may lead investors to have an exaggerated sense of their ability to pick stocks or predict market trends. This often leads to unsound decisions and portfolios that are not adequately diversified.
Loss Aversion (emotional) – A high sensitivity to losses and gains or trying to avoid the feeling of regret often causes investors to hold on to an investment for too long or delay making financial decisions. There is a tendency to be more concerned about negative consequences than positive outcomes resulting in missed opportunities to grow your wealth.
Herd Mentality or the Bandwagon Effect (cognitive) – We all remember our parents saying that just because our friends are doing it, doesn’t make it right! Following the actions of your peers or what seems popular at the time without doing your own research and considering your own risk tolerance is a specific type of financial bias. Unfortunately, this can lead to panic buying or selling and on a larger scale, market volatility.
Confirmation Bias (cognitive) – A person with this bias often seeks only information or opinions that validate their existing ideas or beliefs. They tend to ignore useful financial information to avoid hearing conflicting views or ideas. An example would be to only read articles or listen to financial podcasts that support how you feel about an existing investment making it less likely that you will ascertain both sides of an argument.
We’ve touched on just a few of the emotional fears and biases, but there are many more that can influence the decisions you make about your finances.
As a Behavioral Financial Advisor, Christina helps clients recognize and push past their financial fears as well as identify and mitigate the behavioral biases that may negatively impact their decisions. This is especially helpful during times of life and wealth transitions when emotions are elevated, the stakes can be high, and clients need to make informed, thoughtful decisions.
The Knox Grove team is here to support and guide you on your financial journey. Call us at 609-216-7440.