Behavioral Finance

Money is everywhere. Therefore, as a society, we need to identify what triggers us to make bad financial decisions so we can change ourselves for the better. One’s financial behavior is any action that they take in relation to money. This may include saving, spending, and investment habits. The concept of behavioral finance, on the other hand, draws on ideas from both economics and psychology. Behavioral finance attempts to decipher how mental and emotional conditions affect financial decisions. The difficulty lies in the fact that different people have different motivations and characteristics that factor into their money-making habits. Finding out which money script you are can aid in fixing your financial habits as you can identify issues before they spiral out of control.

Negative behavioral finance is when you have behaviors that hinder the success of your goals. This negative behavior is not based on misinformation or facts; it's caused by emotional triggers that propel one to make bad decisions. However, people’s susceptibility to their varying emotions when making financial decisions comes from a lack of knowledge on financial matters, making financial education of the utmost importance. 

Three important financial literacy mistakes to understand and combat if you want to achieve good behavioral finance are mental accounting, anchoring, and overconfidence. 

Mental Accounting is when you separate money into different accounts based on subjective criteria. An example of this is when you save money in a piggy bank to save up for a vacation while you have debt from the bank. Despite this debt, you refuse to tap open the piggy bank as it feels sacred to you. Although this feels right at the moment, paying off your debts is more important and will lead to more long-term financial stability, which can help you pay for this trip. This is because the longer you wait to pay off your debt, the more interest it accumulates, thus forcing you to pay an even greater amount in total. 

Anchoring is when you tie a money decision to an arbitrary anchor. For instance, there is a common misconception that the cost of your engagement ring should be at least two months of your salary. Many people who follow this strict belief may face financial backlash as not all people have enough money to spend so extensively on a ring. Therefore, it is necessary to ignore arbitrary matters when thinking about financial decisions because, at the end of the day, you need to spend what YOU can afford, not what your friend or a social media influencer can afford. 

Overconfidence is an individual's tendency to overestimate their level of control in financial situations. While a rookie investor may have gotten lucky on one stock, this doesn't mean that they are extremely skilled and can now make risky decisions because they will always do well. However, many people develop overconfidence after getting lucky, leading them to make irresponsible choices that can result in disasters. 

If you participate in any of these negative behavioral finances, by identifying them, you can fix your habits, leading to long-term financial security!