Emotion and psychology affect everything we do. Decisions we make about money are no exception, and how we choose to invest, save, and spend can all be affected by our beliefs, feelings and state of mind.
For instance, although stock market changes are generally consistent with valuations, investors rarely act as rationally. Investors that hear positive reports about a particular investment will flock to drive up the stock price beyond what it’s likely worth, while negative news can considerably devalue the price as investors quickly flee elsewhere.
As investors, we tend to focus on our losses over our gains, even when the big picture is showing us an overall positive direction. We may even avoid certain investments entirely because of their short term risk, despite our intentions to plan for the long term, and forgo potentially higher returns as a result. The field of study focusing on how emotions and psychology affects investor behavior is known as behavioural finance.
But behavioural finance can extend beyond how psychology affects investing. Our overall financial wellbeing tied to saving, and spending behavior is also affected by emotion. Our cultural expectations can shape our financial decisions, anchoring us to one-size-fits-all beliefs that may be irrelevant to our personal circumstances. We are told that it’s foolish to rent and that we should strive to own a home, ignoring conditions where renting is more beneficial to your overall financial health, especially if rising housing costs threaten your ability to live within your means.
Likewise, it’s not unheard of to be told that everyone should have a TFSA, but does it make sense to have a savings account paying very low interest if you’re carrying high credit card debt? Conventional wisdom says we are to spend three month’s salary on an engagement ring, but is it wise to increase your debt burden just to do so? Decisions about what to buy, how much we should save and in which types of accounts, when to retire, and even which pension options to pick are often not made after a rational consideration, but rather through an emotional reaction or the thought that if everyone else is doing it, so should you.
Visit investopedia.com/university/behavioral_finance/ for more information about behavioural finance as it relates to investing. You can also check out the Manitoba Financial Literacy Forum’s Tools and Resources section for more ways to develop your skills, knowledge confidence for making informed financial choices.