At some point in your life you’ve been stressed out about how you’re going to pay for an upcoming bill or an unforeseen expense. That panic you felt and anxiety about money is common to most people and has been the subject of recent studies at Princeton, Stanford, and Yale. The core of this study was to determine how the brain reacts to different money situations. For example, if you’ve ever dined out at a restaurant and splurged on a $100 bottle of wine you might have felt that it definitely tasted better than your usual $15 bottle you would drink at home. This study discovered that when participants were handed two glasses of the same wine but were told that only that they were the same variety of wine, but one was $100 and the other was $15, that the majority of participants strongly preferred the taste of the expensive wine over the cheap wine even though they were actually identical! After digging through this study I’ve taken my top 4 brainy tricks to make sure you are making the right financial decisions.
1. Understand and be careful of confirmation bias
Confirmation bias it when you look for justifications for your decisions that you’ve already made by only looking at things that support your decision and either ignoring or downplaying things that make your decision seem poor. A good example of confirmation bias in action is looking back at the dot com boom in the stock market. It seemed like anybody who didn’t plow their extra money into these dubious internet companies was crazy, but after the dust settled those who were careful and either did not invest or only invested in solid companies with good fundamentals made money. If you lost money in the dot com bubble you probably justified your actions saying at the time it was smart, but really you didn’t do enough research. An easy way to avoid the trap of confirmation bias is simply to pause before you make a big financial decision and ask yourself, “what could go wrong here?” By running through the possible negative outcomes of your decision before you make it you can better understand the risks of your decision.
2. Avoid “Analysis Paralysis”
It is easy to become overwhelmed by the variety of choices to invest your money in. Stocks, bonds, mutual funds, cd’s, IRA’s, 401k’s, and each of these with numerous choices and fee structures. Even if you’re trying to be responsible and understand the types of investments you’re looking at in just one of these categories you can quickly become bogged down in the details and put off making a decision for a later day and miss out on returns. Strategies to avoid analysis paralysis are surprisingly simple, and involve breaking your big decision into a series of small decisions. For example, if you have $5,000 to invest your first step would be to decide if you are investing in a retirement account or your personal account? Make a decision there and move on to the next step, how risky are you going to be and when will you need to take this money out? Choose stocks, bonds, or mutual funds and dive in to choose specific funds. Breaking down complex decisions into smaller ones can keep you from getting stuck and failing to take action.
3. Force yourself to make decisions
Following on my last point, there are other strategies that exist to help force you to do the right thing with your money. Being responsible to another person or an organization can help you stay on track with your financial decisions and avoid distractions that can pull you off course. A few years ago after doing my personal annual audit of my expenses, I found that I spent an awful lot of money on concert tickets as my good friend and I would head out most Fridays to see what bands were playing locally. I spoke to my friend who went in on the tickets with me and we agreed that at this stage in our lives we should probably put our money elsewhere to be more responsible. We entered into a commitment contract with each other that we would only go to one concert per month and we would plan well ahead to avoid expensive tickets. At the end of 6 months we’d both pitch in and get great seats to a show we were both excited about. Keeping tabs on your own spending is tough, but when you have a friend or family member in there with you then you can be nudged into doing the right thing. Out of my concert ticket experiment we each ended up padding our IRA’s with the extra cash and still got to enjoy some amazing live music.
4. Be vigilant for scams
Nobody thinks they’re susceptible to con men and scam artists until it’s too late and they’ve already lost a chunk of their savings. Be extremely vigilant for conmen who may appear around times that you are under particular stress, like after a birth or death in your family, or when you’ve already lost a lot of money on something. Scammers know that when you are stressed you won’t be thinking clearly and there may be an opening for them to move in and take money from you. When considering a new investment always ask for references from prior investors, credentials from licensing authorities, prospectuses or other financial documents, and anything else you can use to verify the legitimacy of a possible investment. Most times if it sounds too good to be true, it is and you just need to know when to walk away.