6 Tips for Overcoming Psychological Mistakes when Managing Money

The evidence from psychology, behavioral finance, and investments tells us that there is range of diverse psychological mistakes people make with their investments. They are categorized into two areas: cognitive and emotional.

By Dr. Marty Martin
: April 29, 2015
Psychological Mistakes when Managing Money

The stock market is booming once more, and as much as we would love to believe that the market will keep climbing forever, we know that it will fall at some point. And, when it falls, will our thoughts, feelings, and behaviors impact our ability to make wise financial decisions?

We cannot control the ups and downs of the market, but we can control our decisions and actions about how we respond to changing market conditions. The focus here is to explore our thoughts, feelings, and actions and how they influence our investments.

The evidence from psychology, behavioral finance, and investments tells us that there is range of diverse psychological mistakes people make with their investments. They are categorized into two areas: cognitive and emotional.

Cognitive
Our cognitive mistakes are the result of faulty problem solving and decision making. Examples include not thoroughly researching an investment prior to making a decision (confirmation bias), not questioning your judgment about your own problem solving and decision-making abilities (overconfidence), and continually seeking additional information to make the “perfect” decision (analysis paralysis). We all know there are no perfect decisions.

If the market goes up, we tend to congratulate ourselves, and if the market goes down we look for somebody to blame. In reality, we should consistently look at ourselves, advisors and the market, because it is the combination of these three factors which determine how well we utilize our money. Psychologists call this the “self-attribution bias."

This is good for maintaining a healthy self-esteem, but does not encourage you to learn from your mistakes. As an example, let’s say that you held onto a declining mutual fund in 2007 through 2009 because you knew that your decision was a sound one. In short, you rode this mutual fund way below its high and when it approached a value far below what you initially paid you blamed the market. 

You had three choices: (1) to sell at a pre-determined amount or percentage loss; (2) to ride it down to nothing; or (3) to monitor the situation and be willing to adjust. The question for the future is as follows: Which of these three options will you choose when your retirement or investment account is dropping like lead at some point in the future? Remember, investors make money by buying low and selling high, not buying high and selling low.

3 Tips for Overcoming Cognitive Mistakes when Managing Your Money
Our thoughts occur so fast that some experts refer to them as “scripts” or “automatic.” There are three tips for overcoming the cognitive mistakes that may cost you money.

  1. Increase awareness of the external event/trigger/feeling/thought/action “chain of events.” This awareness can increase conscious and deliberate decision making. In fact, there is a tool developed by. 
  2. Involve others in very important decisions and actions. Then, the process is slowed down and another set of eyes can frame the decision and at least hear how you are approaching the decision and the behavior. Caution: Do not select a “yes-man/woman” for your thinking partner. To do this would be to fall victim to confirmation bias (cognitive mistake). 
  3. Debrief past decisions/actions (good, bad, and ugly) and ask these three questions: (1) What did I learn from this decision action?; (2) What did I do well that is worth repeating? and (3) What could be done differently or better next time?

Emotional
Emotional mistakes revolve around feelings individuals have with regard to their lives, money in general, or a more specific financial problem or decision. A common example includes making a decision when feeling nervous, sad, mad or even fatigued or physically ill. Other examples include experiencing regret after impulsively making a decision and making a financial decision to change your mood rather than find alternative ways to regulate your emotions. 

3 Tips for Overcoming Emotional Money Management
Emotions are almost automatic; they’re rapid. Before you know it, you have committed to a decision that, at times, you are not even aware you consciously made. Below are three tips to overcoming emotional money management.

  1. Monitor your thoughts, feelings, and physical sensations.
  2. Identify the source of your thoughts, feelings, and physical sensations.
  3. Create distance between your heightened thoughts, feelings and physical sensations and making a deliberate decision.


Monitoring Thoughts, Feelings and Physical Sensations
Knowing what you are feeling is very important so that you do not make a decision under distress or intense anxiety or even when saturated with sad feelings. To be frank, you don’t want to make important financial decisions when you are bounding with confidence or extremely happy. As such, it is important to make money decisions when you grounded and centered.

Identifying the Source of Heightened Thoughts, Feelings and Physical Sensations
Not only is it important to pause before making an important money decision when overwhelmed by rapid-fire thoughts, heightened feelings, and distressing physical sensations; it is also critical to ask, “What is the source?” If you can determine the source and look for patterns, then you may be able to prevent these from occurring as regularly. Remember, we are creatures of habit. For instance, someone might feel clammy, warm and worried whenever they saw a commercial about retirement, or even if the topic of retirement came up in a casual conversation. This person learned that the word “retirement” was a trigger, and was taught not to make any important money decisions without pausing when this word surfaced. 

Creating Distance
A relatively easy way to overcome emotional money management is to create distance between what you are thinking, feeling and sensing and the actual decision or behavior. Distance can be created by waiting for a specified period of time or by discussing the situation with another person. Be sure to discuss the situation with a person that is calmer and more deliberate than you at that time. The last thing you want to do is to work each other up into frenzy. 

These three tips to overcoming emotional money management should serve as your life jacket when swept away by a sea of running thoughts, amplified emotions, and worrying physical sensations. 

One of the greatest lessons to be learned from psychology is that you cannot control many external factors in life, such as the stock market, but you can influence how you respond to these uncontrollable external factors. This makes the difference in the consequences that you experience. Rather than be a control freak, consider being an “Influence Freak,” as there is a lot more you can influence in your life overall and your money life in particular. 

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Dr. Marty Martin is a speaker and author of the forthcoming book Career Insurance. Known for his state-of-the art content presented in an engaging, dynamic fashion, he has been speaking and training nationally and internationally for more than 30 years. Along with his role as a corporate speaker, Dr. Martin is the Director of the Health Sector Management MBA Concentration and Associate Professor in the College of Commerce at DePaul University in Chicago, Illinois and practices at Aequus Wealth Management. For more information or to contact Dr. Martin, please visit his website at >www.drmartymartin.com.

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April 23, 2015
Categories:  Financial Issues