Most of us would love to have perfected ways to not mess up our finances. Yet, given how complex managing money is, it’s no wonder we’re not always the best. But, aside from studying for years to become experts at financial management, we should consider the link between the growing field of behavioural finance and wealth management.
First we should figure out what behavioural finance is and then see how it applies.
Behavioural finance defined
As Investopedia summarises:
“Behavioral finance is a relatively new field that seeks to combine behavioral and cognitive psychological theory with conventional economics and finance to provide explanations for why people make irrational financial decisions.”
The importance of it is that it refocuses people as not being entirely rational, acting and behaving because of factors beyond their control. These often lead to bad financial decisions and terrible management of wealth.
Bad traits to avoid
The Royal Society for the encouragement of Arts, Manufactures and Commerce (or the RSA) compiled a recent list of the traits hindering people’s ability to manage their finances. Their report showed that particular bad beliefs shaped behaviours in unhelpful ways.
These are the six they noted.
Cognitive overload: When we have too much to worry about or on our minds, we make bad decisions. This often happens during times of financial distress, meaning we end up making matters worse. To counter this, we should seek professional financial help and try separate our knee-jerk responses.
Empathy gaps: This is when we purchase based on an inability to put ourselves into different stages of time. For example, we’ll buy food on an empty stomach but not when we’re full – this might be a bad choice for various reasons (buying while hungry could be cognitive overload, while full means we don’t save for later). This applies to bigger financial choices, too. The solution again is to be as neutral as possible when acting and acting sooner rather than later.
Optimism and overconfidence: Having unrealistic expectations drenched in optimism means we make bad decisions. We should operate on facts, not fantasy.
Instant gratification: Instead of saving for the long-term and making our money grow, we buy instantly. It feels better. We should be looking long-term (this ties into empathy gaps).
The report continues:
“Harmful habits: automatic or mindless behaviour can amplify a poor financial decision as it becomes a recurring event.
“Social norms: we are heavily influenced by the actions of others; while this can be helpful in certain circumstances, it also contributes to the pressure to keep up with the Joneses through conspicuous consumption.”
In each of these, the common response is one where we should be neutral and operate on evidence. Only in this way can we do better for ourselves in the future.