If you’ve ever seen the mayhem from the middle of the trading floor of the New York Stock Exchange (NYSE), you can be forgiven for thinking it’s a warzone! Whilst most stock exchanges around the world now trade electronically, having cleared out their trading floors, NYSE still hosts the traditional tussle of the floor traders’ open outcries.
But this is not the only place where money mayhem can cause a right kerfuffle. Every day, in all our lives, we face financial tripwires that are linked to our choices. Behavioural finance helps us identify and understand these hidden traps. Financial decisions around things like investments, payments, risk, and personal debt, are greatly influenced by our emotions, biases, and cognitive limitations.
There are five ways that our behaviours can hold back the growth of our wealth; call them blindspots or tripwires, they’re often hard to see, and we need to work on them.
Mental accounting
Nobel Prize-winning economist Richard Thaler introduced this idea in 1999. This concept refers to the different values we ascribe to money, based on subjective criteria, that often has detrimental results.
Herd behaviour
This tripwire is easier to understand, but it’s often hard to avoid due to peer pressure. Herd behaviour occurs when we choose to follow the crowd rather than make decisions based on our own analysis. When our friends, family or colleagues are making specific spending and investment choices, it’s not always easy to make a different decision.
Emotional gap
The emotional gap occurs when we allow extreme emotions or emotional strains (such as anxiety, anger, fear, or excitement) to guide our decision-making process. Often our emotions are a prominent reason why we do not make rational choices.
Anchoring
When we create a benchmark in our financial planning that is based on an arbitrary figure or traditional expectations (because it’s what our parents did) and make decisions around that benchmark, we’re anchoring. This is not necessarily negative, but if the benchmark is not realistic for our personal situation or holds us back from reaching our potential – it can be a tripwire for our financial future.
Self-attribution
Self-attribution refers to a tendency to make choices based on overconfidence in our knowledge or skill. Self-attribution usually stems from an intrinsic skill in a particular area. If we are naturally talented or highly skilled in certain areas of life, we can run the risk of thinking our ability to achieve in those areas will flow into other areas. This is seldom the case, which is why we thrive in a community and not in isolation.
Having a financial adviser is a sure way to identify these tripwires in your financial plan and help you navigate them safely to secure a healthier, happier financial future.