After spending the last ten years in finance, something has been made very clear to me time and time again. Money isn’t always about how much you have or how little you have for that matter. It’s all about your mindset when it comes to money. What you are willing to give up today for your future self, what you need vs what you want, and prioritizing your goals! I have become very interested in the topic of Behavioral Finance over the last few years because not only have I experienced the emotions below, I have seen what a mess can be made when you allow emotions to override logic.
Below are a couple irrational decisions I have made. Now that I recognize these behaviors, I have a much better chance at overcoming them and hopefully you will too!
IT CAN’T POSSIBLY KEEP GOING DOWN
In 2008 – 2009 when we all lost about a third of our investment portfolios (eeek!) I remember thinking to myself, “okay, this is it. No way is it going to KEEP GOING DOWN!” Well, it did. And I had no choice but to hang on to everything. The opposite has held true for me too. Holding an investment that has gone up and up. I think to myself, “it can’t possibly keep going up!?” So what do I do? Sell it of course! And then I get to watch it keep going up. The point is, nobody can reasonably predict what is going to happen with the markets. Investments go up, down, sideways and really there is nothing you can do but have a good, diversified portfolio that allocated appropriately to your level of comfort when it comes to risk. This is referred to as the Gambler’s Fallacy in Behavioral Finance.
Glad I found a word that describes my most destructive behavior! Compartmentalizing, or in other words, creating little buckets of money everywhere for different priorities. Here is the irrational part! A dollar is a dollar no matter which way you look at it. What I do is set aside money in say a vacation fund, but then when I need money for something more immediate (like a new hot water heater) I will put it off instead of pulling it out of the vacation fund (which is liquid and available). Why?! Because who needs hot water when Hawaii is right around the corner? Kidding of course! Because in my head I have put a restriction on my vacation fund where money may enter but it may not leave until vacation time! Makes no sense whatsoever especially since the money is all under the same roof! This can be especially problematic for people who tend to save towards one specific goal while they still have a looming debt balance out there. This is referred to as Mental Accounting.
TIPS TO KEEP MYSELF IN LINE
Keep my emotions out of my investments: The way I do this is by setting up a target allocation for my accounts. Since I am in my early thirties (meaning I can afford to take risk), and I am willing and comfortable to take on some risk, I have my portfolio set up as a 90/10 split of mutual funds and ETFs between stocks and bonds. Drilling down even further it is then broken up between domestic, foreign, large and small cap investments. I make it a point to rebalance when the targets shift 7% or more either way. This keeps me in line and keeps my emotions out of the picture. After all, I have no idea what is going to happen next and my best course of action is taking the gains from my winners and to invest those back into the poor performers. You know what they say… buy low and sell high!
Think in small numbers: Sometimes the thought of $1,000 or $10,000 can be too large of a number for my brain to fully comprehend. Say I’m buying a car for $30,000 and they say, “would you like us to throw in the XLT package for $1,500?” In my brain I’m like, “oh yeah, why not!” So to keep my brain in comprehension mode, I knock off a zero or two. When I’m working with smaller numbers it’s easier for me to understand that a $3,000 purchase is going to have another $150 added on! Perhaps it’s from my excessive couponing days but with those smaller figures it’s easier for me to understand why that isn’t such a great deal! That’s just my brain however!
I also like to think in terms of percentages. So instead of thinking, “oh, it’s just $30 bucks for this useless piece of junk that I DO NOT NEED” and then I subsequently purchase it anyway, I instead say “this is 30% of a hundred bucks!” Then of course I will not buy it because 30% of $100 sounds so much more than $30. Don’t ask me why!!! I do not know why my brain works the way it does!
I have several other things I do to keep myself in line but I’ll save those for another post. The point is that we all think about money differently, put different priorities on our goals (mm…hmm vacation fund), and we have to find our own little ways to change our behavior to get to where we want to be with our money. I’m interested to hear what works for you?