We all make financial mistakes and they add up
Academic research tells us that emotions and experiences can distort our financial decisions. While our mistakes are rarely the result of a single mental error, our feelings can make us fumble. Below, seven big financial mistakes and the psychology behind them.
1. Saving with the right hand and spending with the left
Diagnosis: Mental accounting
Symptoms; Keeping money in a savings account while paying credit card debt at 19%, thinking a tax refund is a reason to spend; obsessing over the price of a new car but not monitoring the weekly grocery spend.
Solution; Look at the whole financial picture, not just the part that you want to see..read more here
2. Playing it too safe
Diagnosis: Loss Aversion
Symptoms; Quick to sell winning stocks but slow to sell losing ones; putting too much cash in money-market funds and not enough in stocks; reluctance to trade away what you already have, even for something more valuable
Solution; No one likes losing money — a truism that economists call “loss aversion.” Because we can avoid only losses that we recognize, we tend to focus on immediate costs, while ignoring more subtle costs and even savings. e.g. we should recognize that getting a $4 discount is worth as much as avoiding a $4 surcharge. But most of us would rather avoid that surcharge
3. Looking into a Cloudy Crystal Ball
Diagnosis; Misunderstanding Risk
Symptoms; Putting too much money into your favourite investment, not diversifying, not putting in place risk protection such as your personal health as well as assets
Solution; Take out appropriate insurance. The majority of people insure their assets yet their biggest asset is the ability to earn. Income protection insurance is just as important and house insurance, if not more important.
4. Living in the moment
Symptoms; Failing to plan for the future
Solution; Work out how much you need to keep the lifestyle you want during retirement and plan your investments/savings accordingly
5. Throwing good money after bad
Diagnosis; Need a reality check
Symptoms; Hanging on in the hope that ‘things’ will improve without looking at facts in the market place
Solution; The market goes in cycles and eventually things improve but only if you can stay afloat financially. Staying in an investment that is losing money or costing you more than you can afford is not the way forward. Sometimes it pays to cut your losses, regroup and start again later. Often more money is made at a later date which makes up for the temporary loss rather than hanging on till the bitter end and have nothing to show for your efforts
6. Letting your ego get in the way
Diagnosis; Over confidence
Symptoms; Losing sight of what is really happening in the market place and thinking you know better. Not knowing when to have a break and consolidate
Solution; Studies show that we often tend to overestimate our abilities. Confidence and optimism are a crucial part of any investor however, over confidence leads people to believe they can beat the market, that the ‘good’ times won’t end and that property prices will keep rising.
7. Following the crowd
Symptoms; Following what other people say or do without doing your own due diligence. Not every type of investing is suitable for everyone.
Solution; Do your own research, not just because it ‘seemed’ a good idea by a group of others. Don’t be easily led, lots of people have lost a large part of their investment because they didn’t check things out properly