How often have you found yourself making impulsive decisions about your investments based on headlines or peer pressure? Maybe you’ve even shifted your entire asset allocation because of these emotions.
If this sounds familiar, you’re far from alone.
Carl Richards, in his groundbreaking book “The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money,” taps into this pervasive psychology, breaking it down for us in layman’s terms.
Richards coined the term “Behavior Gap” to describe the chasm between what we should do with our finances, driven by sound logic and knowledge, and what we actually do, swayed by our emotional tides. This gap is especially noticeable when it comes to asset allocation—the division of investments among various categories like stocks, bonds, and cash. Two key emotions frequently lead us astray here: fear and greed.
Fear has a funny way of paralysing us when it matters the most. In times of market turbulence, this fear often results in us pulling our money out of investments prematurely, succumbing to what is known as “loss aversion.”
This psychological tendency to prefer avoiding losses over acquiring gains can have long-term consequences. On the flip side, greed can turn us into daredevils, lured by the siren call of high-risk, high-reward opportunities. Often, we might even allocate too much into volatile stocks or speculative investments, hoping for instant returns. Either way, our emotional actions can severely impede our financial growth and the attainment of long-term goals.
So, how does Richards suggest we bridge this Behavior Gap? Through the pursuit of emotional balance and simplicity. Though this philosophy sounds straightforward, the implementation is profound. By sticking to tried-and-true investment strategies and maintaining a disciplined approach, we can inch ever closer to a state of serenity in financial planning.
This serenity doesn’t make us immune to the whims of market fluctuations, economic downturns, or external stressors. However, it arms us with the emotional fortitude to keep our eyes on our financial objectives and resist knee-jerk reactions, particularly those driven by fear or greed.
Acknowledging the emotional influences on financial decisions is the first essential step in bridging the behaviour gap that often separates logical planning from emotional action. It’s important to be honest with yourself and admit that feelings like fear and greed can, and often do, skew your judgment. Once you have this self-awareness, it becomes easier to mitigate the influence of these emotions on your financial choices.
The next logical move is to create guiding principles or a “financial constitution” that is in line with your long-term financial goals. These guiding principles act like your personal financial lighthouse, steering you in the right direction whenever you’re tempted to let emotions dictate your actions. In times of market volatility or personal stress, it’s these well-thought-out principles that will keep you on course.
By having a set rulebook to consult, especially when it comes to crucial decisions like asset allocation, you can make choices that are aligned with your long-term objectives rather than short-term emotional reactions.
When we incorporate these steps and internalising the insights, we can close the behaviour gap that separates our actual financial behaviours from the ideal. In doing so, we arm ourselves with the tools to make rational, informed decisions that secure our financial future and align with our long-term life goals.