When it comes to financial wellbeing, sometimes the most significant threats come from our own mind.
We have more information at our fingertips than ever before, making it nearly impossible to keep breaking news and other people’s opinions out of our heads.
Even beyond what we read online, there are several ways psychology plays a crucial role in everyday financial decisions—where to buy groceries, how much to invest, where to donate or volunteer, etc. This concept is called behavioral finance, and it’s more impactful on your financial health than you’ve likely realized.
Below, we’ve identified how to overcome these hurdles, plus a few ways to use them to your advantage.
5 Common Behavioral Roadblocks
As we mentioned above, a few common psychological hurdles tend to impact the way we think about money. Here, we’re breaking down each common roadblock and why it can cause investors trouble.
Overconfidence
Overconfidence is problematic in any number of situations:
A cocky coworker says they’ll exceed the sales goal (they never do).
A wanna-be rockstar hogs the mic on karaoke night (and everyone wishes they wouldn’t).
…You get the picture.
Confidence is great to have, but overconfidence can damage investors’ well-being. It causes wishful thinking, giving investors the idea that they can time the markets. Overconfident investors believe in the latest hot stock, “knowing” they have the wisdom to buy and sell at the perfect time.
But, of course, nobody’s portfolio comes with a crystal ball. Overconfidence can lead investors to create a high-risk portfolio as they focus on short-term gains or losses instead of their long-term goals.
Confirmation
Psychologically speaking, we like to hear information that confirms what we already believe. Being told you’re wrong is a hard pill to swallow—that is, if you even choose to believe that what you’re hearing is true.
When we consume information, we sometimes even interpret it to follow our beliefs and preconceived notions.
Confirmation bias leads us to make money decisions based on biased research. We naturally want to listen to sources we know follow similar beliefs to our own, and reject sources that offer opposing information or views.
The problem is that this creates a narrow field of vision for your investments. For example, your confirmation bias could lead you to over-invest in specific markets or sectors. Investment decisions should be data-driven or education-based, and the confirmation bias can make that challenging to do.
Loss Aversion
It’s tough to watch your portfolio go down in value. But focusing too much on the losses and not enough on the gains can create a loss aversion bias. If this is the case, you risk foregoing certain opportunities for returns because the risk of loss is too upsetting.
This is a common bias, and understandably so. For investors with a loss aversion, avoiding a loss is even more important than creating an opportunity for gains. This mindset leads these investors to focus too much on conservative assets, like CDs or bonds. However, a diversified portfolio should consist of an assortment of risk levels and asset types.
Hindsight
Shoulda, woulda, coulda—right? We’ve all regretted things in hindsight, and missed opportunities for investing are likely on the list. Hindsight is a great way to reflect on your own mistakes or wins. But as a bias, it can cause trouble for investors.
As we touched on with the overconfidence bias, there’s no way to accurately predict market outcomes all the time. But sometimes, hindsight makes us think we know a lot more than we actually do. The 2008 stock market crash, for example, had some investors swearing they knew exactly what was going to happen before it did (and they definitely did not).
Hindsight is a dangerous and unproductive bias, as it can lead to overconfidence in our abilities to predict or time the market.
Bandwagon
Remember meme stocks, like AMC and GameStop?
Hot stocks grab our attention, and missing out on the opportunity to get-rich-quick can cause some serious FOMO. But following what other investors are doing, whether they’re friends, relatives, or strangers on the internet, can lead to a bandwagon bias.
With a bandwagon bias, investors tend to listen to the loudest voice in the room, whether they really believe in what’s being said or not. Unfortunately, the advice of others will not always align with your financial well-being or long-term goals.
Identifying Your Roadblocks
Even when you understand the most common behavioral biases, it’s tough to identify them within yourself.
Keep an open mind when making investment decisions, and remember to give yourself a little grace. Everyone has some financial habits they’d like to change or improve, but identifying them is a great first step.
At Woven Capital, you’ll never get any shame, blame, or judgment from us. Instead, we focus on peeling back problem areas and developing healthy decision-making habits based on knowledge and know-how.
How Money Biases & Impact Investing Work Together
We are big proponents of investing based on your values and principles. That’s why we enjoy working with clients who’ve chosen to prioritize SRI and impact investing.
Unfortunately, it can be harder to catch and reconcile with your own biases when investing based on values. We work with socially conscious investors to build a portfolio based on their beliefs and driven by performance. With the options available to SRI investors today, there’s no reason to compromise on either.
If you’re interested in SRI investing or finding ways to overcome your own behavioral biases, feel free to reach out to our team today.