- Fear is a powerful emotion. And when it gets involved with your finances, it can end up costing you.
- Instead of “trusting your gut,” set a long-term strategy and stick to it. Working with a professional can help.
- A mindfulness practice can also help you separate fear and anxiety from your money decisions.
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 principles. 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. (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!
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…
Read More: 3 Things You Can Do to Stop Your Emotions From Ruining Your Finances