We often associate the word ‘behave’ with acting properly, but how does that translate when it comes to your finances? There is no hard or fast rule but for some, it may mean having no liabilities, such as credit cards, or even a mortgage. For others, it may mean budgeting your monthly or annual expenditure within the confines of your income. Easier said than done!
Don’t worry, I’m not about to tell you to give up your daily takeout coffee, but much of my role is about understanding how our clients’ circumstances, background and life experiences subsequently drive their decision making. I do not profess to being a psychologist but it’s fascinating how much human behaviour is involved when it comes to managing money.
I wanted to reveal some key behaviour traps to be aware of, for when you plan the time to ‘hopefully’ review how you budget, manage or review your own investments and finances.
Behaviour Trap 1
Have you ever been clothes shopping and the item you longed for, originally priced at £100, is now down to £80. The natural behaviour here is to rely too heavily on the first piece of information (£100), and the £80 item now appears like a bargain, resulting in a purchase. This is called anchoring, and this bias can lead to sub-optimal decisions. Whether it’s an item of clothing, a holiday, or a company’s share price, it can cloud our judgement and prevent us from seeing the true value of something. It is essential to do your research and consider a range of information before fixating on a price or initial figure.
Behaviour Trap 2
Mental accounting is a concept which explains how people typically categorise, track and manage their money in different “mental accounts” based on factors, like the source of the money, or its overall purpose. While it can be useful to segment finances, if you become too rigid in your approach, this can make it difficult to reallocate resources. Focusing too much on individual pots can also make it difficult to see your overall financial situation. This could lead to missing opportunities for better financial planning or investments that could benefit you in the long-run. It is important to ask yourself this question: have you ever treated money differently based on the label you gave it?
Behaviour Trap 3
Have you ever felt like the next Warren Buffet because your investments did great last year? Well unfortunately you are now displaying something called hindsight bias, making you think you “knew it all along”. It’s like planning the perfect holiday for your family one year and then assuming this year’s trip will go just as smoothly. There is a reason behind the highly regulated sentence, “past performance is not an indicator of future performance”. Each situation we face in markets has new and often unpredictable factors. This is why it’s so important to plan and manage your expectations when it comes to stock market returns.
There is value to appointing a professional investment manager or financial planner to work side by side with you. Developing a trusted relationship is vital so that your professional team can challenge and probe these behaviours to help you make more informed decisions when comes to your finances. They are trained to not fall into anchoring, mental accounting or hindsight bias. It isn’t always easy, but they will help to make it so.
If you are looking to review your existing investments or looking to start out on your investment journey, we can help.
With investments, your capital is at risk.
