Our emotions are powerful and often influence the decisions we make in life, sometimes without us even realizing it. This is especially true in the realm of financial decision-making. At Sherman Wealth, we frequently discuss behavioral finance with our clients, emphasizing how our behaviors can oftentimes significantly impact the financial choices we make. As you build out your financial plan, it’s important to acknowledge your emotions and discuss how they impact your financial thought process.
Investment biases can get in the way of making objective financial decisions. By recognizing and understanding these biases, you can learn to avoid them and in turn, unpack your emotions to help build out your financial plan. Here are some key behavioral biases to be aware of:
Loss Aversion
Loss aversion occurs when individuals fear an imminent negative outcome, such as a market downturn. This fear can prompt investors to sell their stocks prematurely when the market starts to decline. At Sherman Wealth, we stress the importance of long-term strategies and the value of “time in the market.” When you feel anxious about market fluctuations, your asset allocation may not be appropriate with your risk tolerance.
Bandwagon Effect
The bandwagon effect refers to the tendency to follow the investment decisions of the crowd simply because they are popular. It’s important to do your own research and feel confident in an investment decision rather than jumping on the latest trend.
Sunk Cost Fallacy
The sunk cost fallacy is the difficulty in moving on from a poor investment due to the time and money already invested in it. If an investment is continually underperforming, it might be best to stop investing further resources into it and consider moving on. Holding onto a bad investment just because of past commitments can prevent you from making better financial decisions.
Confirmation Bias
Confirmation bias is the tendency to seek out information that confirms our previous decisions, often clouding our judgment. Before making significant investment decisions, it’s essential to conduct thorough research to ensure you are making informed choices. Avoid relying solely on information that supports your initial views and be open to different perspectives.
Confronting these behavioral biases can help you make clearer, more rational financial decisions in the future. If you have any questions or would like to learn more about confronting and even avoiding negative behavioral biases, email info@shermanwealth.com or schedule a complimentary 30-minute meeting with us to revisit and create your financial plan.
