What is Behavioral Finance and How Can a Financial Group Help
Behavioral finance is based on the psychological reasons we react to money the way we do. Yes, there is science behind why people feel, spend and save a certain way.
The truth is, human beings are not always rational when it comes to finances. Money evokes emotional reactions. Some of the common reactions are fear (will I have enough), pleasure (I want it) and hindsight (I don’t want to end up where I was before so I don’t need it).
Behavioral finance is one of the reasons why working with a financial advisor can be so beneficial. Having a perspective on decisions when it comes to your money can help you make the right decision instead of an emotional one.
Here are some common reactions:
The Fear of Missing Out (FOMO) is a real thing. We see this happen in young people as well as retirees – a friend has a trip or an experience that sounds too good to be true, and regardless of whether the money is available, a decision is made – “because you only live once.”
This can be dangerous to your long-term goals. Instant gratification can put people into debt that ultimately takes money away from retirement funds and savings.
The answer isn’t to deprive yourself of everything. There are ways to plan for these expenses. Talking with a financial advisor about ways to save for vacations can leave you in a better position and help you prioritize adventures when they come up.
Another common reason for spending outside your means is the pressure you may feel to keep up with neighbors, friends, family or coworkers. TV doesn’t help as programs show extravagant lifestyles, homes, cars and vacations. We’ve even seen parents succumb to this pressure when it comes to their children’s education, family trips and celebrations, like a wedding or a birthday.
A financial advisor, a budget and a comprehensive and holistic plan for reaching long-term goals can help prioritize needs, wants and spending habits.
Not all behavioral finance has to do with living outside of your means. There are also many common reasons people don’t spend. This is common with parents and retirees who fear another recession or market crash.
While this may seem more cautious, this can also have negative effects. Working with a financial advisor who is familiar with the market and has experienced different scenarios can help provide confidence that spending money is OK when it may not feel like it.
We talk a lot about impulse buys and not pausing before making a purchase. We encourage people to take a breath before buying something they may not need and ask themselves a few questions:
- Do I really need it?
- Do I love it?
- Will it make me money? (This is especially important for business owners.)
A short time to reflect can help prevent unnecessary purchases that can get you into financial trouble.
There’s a big difference between responding and reacting. For example, you may see a trendy jacket that you feel like you need, and quickly react – I love it, I want it and I’m getting it. But if instead you paused, asked yourself a few questions and then responded, you’re more likely to make a smart decision.
Another psychological reason we see for responding to finances a certain way is naivety, or rose-colored glasses.
Without a plan in place, or sometimes even a thought about retirement, some people just assume they’ll be able to retire how they want and when they want. “It’ll be fine.” But will it?
A comprehensive financial plan is like a roadmap to a place you want to go (retirement). While the road to retirement might not be as smooth as you had hoped, a plan can help you adapt. There will be roadblocks and detours (a leaky roof, an expensive healthcare bill), but when you discuss your income, your goals and what-if scenarios that you may encounter, a financial advisor can help create a plan that allows for these hiccups.
The opposite of rose-colored glasses is fear. Let’s be fair, life is worth living. Living in fear can be just as bad as living with no fear. There needs to be a common ground.
Discussing your options and your concerns with a financial advisor can give you confidence that the money will be there. Regularly reviewing your plan is also recommended, at a minimum, once a year. This allows investors to track their portfolio’s performance and their progress toward reaching their goals. It also allows investors to make any necessary changes early on.
It’s true: Not everyone needs a financial advisor. If you are financially savvy, if you understand how the stock market works and know what to look for, then it may make sense to handle your financial needs on your own.
If you don’t fit into this box, it’s wise to work with someone who does.
Unfortunately, we see this a lot – people try to do it all themselves and they make mistakes. Some mistakes can be overturned, especially when you’re still working and in your accumulation years. But others can be detrimental, and as you get closer to retirement, there can be less time to make up for lost money.
You don’t have to do it alone. If you own a home and the roof starts to leak, most people call an expert to fix it – water damage can lead to some major issues. However, when it comes to creating a financial plan, some people try to take the task on themselves.
Financial planning DIY-ers often make the emotional mistakes listed above. They may react and make major decisions after losing a loved one or experiencing a major life event. They may overlook an estate plan and their assets are not protected the way they had hoped. There are a number of things that can go wrong.
This material is provided by PAX Financial Group, LLC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information herein has been derived from sources believed to be accurate. Please note: Investing involves risk, and past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly. All economic and performance data is historical and not indicative of future results.