YOUR MIND AND YOUR MONEY (part 2)

By in Guest Post, Mind and Money

4 Misplaced Financial Beliefs Could be Preventing You from Achieving Financial Success

Welcome to Part 2 of this series detailing how your mind may hurt your financial situation by guest contributor, Ornella Grosz.

Money and Your Mind

Check out Part 1; Your Mind and Your Money-Investors are Not Rational; Learn How to Use Your Mind to Combat Money Mistakes

Misplaced Beliefs

In part 1, we talked about trusting your gut and increasing awareness of our beliefs. To clarify, misplaced beliefs are beliefs you perceive as truths. As I delve a little into our psyche, I’m going to tackle four misplaced beliefs.

1. Forecasting errors can lead to poor investment decisions.

Behavioral finance researchers Kahneman and Tversky found that people overweight recent experience and believe the recent past will continue into the future.

When the 2008-2009 financial crisis threatened and depleted the average persons financial assets, you or someone you know may have felt it. And when we feel threatened, we intuitively assess the risk—it’s that fight or flight mode. In fact, as stock values tanked, many investors feared that they would never recover their losses and that stock investments would never outperform again. This caused the unfortunate few to sell out their losses at the bottom, only to watch the market fully recover over the next few years.

2. Stereotyping can hinder our financial decision making.

Some people assume women are more risk averse than men, especially when feeling financially threatened. According to a 2010 study published in Psychological Science, “Stereotype Threat Affects Financial Decision Making”, by Priyanka B. Carr and Claude M. Steele only when prompted with stereotypical ideas (ie women are bad at math) did gender stereotypes hold.

When the male and female volunteers were prompted about the negative stereotypes, the gender differences emerged—women were more likely to avoid risk and losses.

When the volunteers were not hinted, there were no gender differences in financial decision making. Both sexes were moderately loss and risk averse. The stereotypical cues—negative for women, positive for men—encouraged behavior related to the stereotype.

The takeaway; reduce and remove these gender stereotypes—women are more risk and loss averse, men are more risk-takers—both men and women are free to make the financial choices and decisions they think are best.

Something to think about, eh? Personally, I’m very aggressive with my investment choices and with other financial choices a little cautious. I’d like to think that growing up I didn’t succumb to this type of negative stereotype. However, I’ve met those who have. And I venture to say that perhaps it’s part of the reason women formulated “hidden scripts” .

3. People are seduced by the status quo.

As busy people, we are trying to cope in this complex world. Because we are busy and have short attention spans we have less time to think about every choice we make. Thus we seek convenient solutions. If something seems to fit in line with the way we think (perception), we will treat it as our truth.

Additionally, we prefer that things remain the same, or that things change as little as possible, if they absolutely must be altered—dubbed “status quo bias.” You make the easy choices, not necessarily the best choices. For example:

  • Subscribe to a magazine for the free trial period and forget to cancel it afterwards. You have good intentions to cancel, but for some reason you never seem to get around to it. This decision hurts you financially by paying for something you really don’t want. (That’s why I avoid the temptation to take up these short term offers. It’s just too much hassle to remember to cancel. Barb’s comment)
  • Set up your retirement plan to a specific asset allocation and never review or rebalance. (You need to rebalance your accounts every year to keep them in line with your initial investment choices. Barb’s comment)
  • Making very conservative financial choices, without considering your age, or risk tolerance.
  • Accept a higher car insurance premium without calling up the company to find out the reason for the increase or searching for  a cheaper alternative.
You become stressed when a situation forces you to make a financial choice and so after making your initial decision, you remain closed minded to a better opportunity. Maybe you stick to the status quo because you lack the confidence to compare the alternatives or are overwhelmed with the available choices.
In today’s world, financial literacy is more important than ever to help make better financial decisions; otherwise, you revert to poor habit driven decision making.

4. Financial rules of thumbs are short-cuts to break down complex financial choices.

Rules of thumbs are better known as heuristics. Here are some examples:

  • Pay off debt with highest interest rate first.
  • Use 4% as a safe withdrawal rate at retirement.
  • Pay off your mortgage.
  • Refinance your home when interest rates have dropped by 1%
  • In retirement, you’ll need to replace 80% of your pre-retirement income.
  • Save at least 10% (you might need to save at least 15%).
  • Life insurance should equal X times your income.

The truth is we are not hard-wired to think for the long-term; therefore, envisioning and planning for the future can be a challenge. Sometimes, I think that’s why some people struggle with savings. Financial rules of thumbs help us speed up the process to making a decision without having to over think it. They help us to navigate with ease.

At the same time, they can be perilous. Adhering to such rules may not always be the right financial decision for your financial circumstances. Our minds naturally gravitate to things we are familiar with, and the above examples are all things most of us have heard.

I’m not saying to ignore all financial rules of thumb. I like that they provide a general guideline. Personal finance is more personal than it is finance. And rules of thumb can help us manage our money better. But when people only use rules of thumb, they could be missing out on better opportunities or strategies.

How to Combat Misplaced Financial Beliefs

Since we have a natural tendency to confirm what we think we know or already know, I think I have a solution: consider looking for facts to support information that contradicts your beliefs and biases. Ultimately, you’ll change your perception.

I would like to leave you with a quote from John Maynard Keynes:

“The real difficulty in changing the course of any enterprise lies not in developing new ideas but in escaping from old ones.”

Check out Part 1; Your Mind and Your Money-Investors are Not Rational; Learn How to Use Your Mind to Combat Money Mistakes

Ornella Grosz, CFEd® is financial expert, keynote speaker, author of Moneylicious: A Financial Clue for Generation Y, and member of the National Financial Educators Council (NFEC) Financial Literacy Curriculum Advisory Board. Emerging as the optimistic financial voice during a turbulent and uncertain economy, is an advocate for young adults, women, and beyond (she doesn’t discriminate) to view money differently. She blogs at Moneylicious adding a little spice to money matters. Join her @OrnellaGrosz.

Can you think of other misplaced beliefs? Or, what are some financial beliefs you grew up that has worked for you?

image credit; google images, following my passion 2 success blogspot