What Type Of Financial Behaviour Are You Falling Prey To?
Happyness Factory is a Goal-Based Financial Planning platform. We help you take purposeful money decisions and invest in a HappyRich tomorrow.
26 Jun, 2018
Have you ever felt you missed the bus when it came to a particular investment or regretted an investment decision that you were very confident of? There’s a high chance your emotions and psychology are impacting your money decisions!
While focusing on the next multi-bagger, top performing fund or booming real estate investment, we end up ignoring the most important factor that impacts our family’s financial well-being – our behaviour and emotions towards money. Our emotions, previous experiences and psychology play a big role in any financial decision-making process.
Most of us end up making seemingly irrational or illogical decisions when it comes to finances. Which type of behaviour do you exhibit when it comes to money? Have a look at the list below and ensure you always make right decisions when it comes to money:
1. Mental Accounting: The behaviour of treating money differently based on its source is a grave mistake most of us make.
You are prone to mental accounting if you win Rs. 50,000 at a lucky draw at your gymkhana at their monthly games night and go on a shopping spree but you wouldn’t dream of spending the same amount on shopping had it been your hard-earned money.
Just because you have won a lottery, received a windfall or a gift does not mean that the money does not belong to you or that you need to treat it differently. Think of your money (all inflows and outflows) in terms of your balance sheet and not something that you bracket depending on from where it has come from. Never act immediately when you receive a bonus or windfall.
2. Decision Paralysis: Decision Paralysis is the delay in taking investment decisions or the inability to choose between various investment choices. You are afflicted with decision paralysis if you –
- Wake up every morning and read reams of financial newspapers to find ‘stock tips’
- Scrutinize websites that analyse and recommend stocks to find a potential multi-bagger
- Consult your broker and friends about a particular stock or insurance product
and still don’t make any investment decision!
Read about how you can avoid being a perpetual fence-sitter here
3. Loss Aversion: Loss aversion refers to the tendency to prefer avoiding losses over acquiring equivalent gains. Loss aversion is something that comes into play in our everyday life quite often. When you buy a movie ticket for Rs. 400 and the movie is terrible, your loss aversion is what stops you from walking out of the movie in the interval. You would rather not let the money you spent on the ticket go ‘waste’.
This is how your feelings towards loss can force you not to exit investments or wait too long or put in more money in an unfinished project.
4. Anchoring: Anchoring is when you often hold on to a fact or figure and use that as the basis or reference point for making future decisions.
You are falling prey to anchoring if you have been in situations like these –
- You select an umbrella in a shop and it has a price tag of Rs. 1000. Normally you would have bought it without second thoughts, but you had seen a similar umbrella being sold by a vendor at a traffic signal for Rs. 200. Now every umbrella in the shop seems too expensive and even though the quality of the umbrella seems better you aren’t willing to pay more than Rs. 200 for an umbrella.
- “I want to sell my extra property for Rs. 3 crore. In June 2017 Builder X offered Rs. 2 crore to my neighbour, Mr. Bhatia for his flat. Now 1 year down the line, he should offer me a higher price as one year has passed and prices would have increased. Also, my flat has a better view than Mr Bhatia’s flat.”
Decisions based on anchoring are not only rudimentary but can be dangerous for your long-term financial health.
5. Overconfidence: Overconfidence mostly depends on the external economic and your internal economic situation. People are extremely bullish during good times, but chicken out during bad or tough economic times (even though their situation does not warrant so). You are afflicted with overconfidence if you think:
- Real estate is the best investment and there is no way one can lose money in real estate
- You have made a wise decision by buying an investment-oriented life insurance policy despite someone telling you a term plan is the way to go
- You can identify the next Infosys of the market and can also easily explain the faulty choices you have made in the stock market
- You don’t need a good financial advisor because you already know a lot
If you understand these behavioral issues well, you can use them to your advantage. Most often our belief system and ignorance make us feel what we are doing is correct and there is no other way to approach finances. Identifying that you are prone to making mistakes or taking one-sided decisions is the first step to not making them.
What also helps avoid making money mistakes is giving your money a purpose. When you have a goal in mind and are saving and investing towards achieving that goal, you are more likely to stay focused and not let your greed or indecision come in the way. Giving your money purpose and focusing on goals ensures you don’t get carried away by multiple investment avenues and select what suits your needs and requirements.