You’ve probably heard that you shouldn’t let your emotions drive your financial decisions.
Yet that may be harder than it sounds, especially when the market sells off.
In fact, there may be a number of psychological biases holding you back from building wealth. That’s because the part of our brain that allows us to imagine the future doesn’t move as fast as the part that governs emotions, explained certified financial planner Michael Finke, professor of wealth management at The American College of Financial Services.
“The emotional part of our brain was effective when doing things like avoiding saber-toothed tigers, but it may not be as effective in a modern economy,” said Finke, whose research includes individual investor behavior.
It could result in selling off investments just to pacify the emotional part of the brain, instead of thinking ahead.
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The good news is there are things you can do to overcome these biases.
“Knowledge is power,” said licensed marriage and family therapist Dr. George James, chief innovation officer and senior staff therapist at the non-profit Council for Relationships. “The more that you learn, the more power you have.
“Learning can be from what you read, what you listen to, who you connect with.”
Here are six biases to look out for and how you can conquer them.
1. Loss aversion
By far the most powerful emotional bias, loss aversion refers to the desire to avoid any risk that could result in a loss.
It could lead investors to sell something after it has fallen in price and buy more of something that has gone up.
“That can explain why many investors underperform the market,” Finke said.
Instead, make your investment decisions using the rational part of your brain and then ignore them, he advised. Set up a system that will automatically rebalance your portfolio so that you aren’t making changes based on emotion.
“When we plan for the future, we are using that rational part of our brain,” Finke said. “That is why it is so important to think about what our financial goals are.”
2. Endowment effect
People tend to value something more highly once they own it. For instance, you may have inherited some stock from a relative or invested in an asset that has gone up in value.
“Once we become emotionally invested …….