Behavioral Finance 101

Behavioral finance sounds like a laborious upper level college course required for financial geeks, like myself. But, behavioral finance (at least my definition) is actually one of the top driving forces behind the successes or failures in our personal financial lives.

Investopedia’s definition of behavioral finance: a field of finance that proposes psychology-based theories to explain stock market anomalies.

My definition of behavioral finance: the behavior we exhibit which impacts our personal financial well-being.

Okay, this definition is not found in Webster’s dictionary.  There’s probably not a college level course in this area…..although, I feel there should be.

Our financial success or failure is highly correlated to the financial behavior we exhibit.  For those born into wealth, or independently wealthy, the impact may be less….but not always.  For most of us, our behavior speaks volumes about our financial success.

Do we spend more than we earn? Do we save? Are we tax efficient?  Do we have financial addictions?

As a fee-only financial advisor, I often speak about controlling the things we can control, which essentially means controlling our actions or behavior.  We can’t control the stock market, so we don’t try to control it. We manage our investments by creating portfolios to participate in growth periods, hedge against inflation, and hedge against the deflation.

We can’t control Mother Nature and predict the next damaging storm that passes our way. But, we do manage our risk exposure by properly insuring our property, valuables, and our earning potential (our life).

If we are doing the right things in our financial lives and behaving in a balanced manner, short term market moves shouldn’t make us or break us.  This is not to say that market downturns won’t hurt.  I’m simply stating that for most people the financial behavior you exhibit will impact your financial well-being more than the ebb and flow of the stock market.

Establishing good habits, such as dollar cost averaging into the market, saving at least 10% of your income, coordinating taxes and investing, living within your means, and eliminating debt will ultimately trump the market.  Let me state it another way…..Hitting a home run with an investment (say a single stock) or investments (the total portfolio) will not trump bad financial behavior. Sure, it might be fun trying to spend the buckets of money someone may have made after buying Apple stock at $20 a share, but bad behavioral finance knows no limits…..only the zeros change.

If you are frustrated with your financial world, don’t immediately turn to the stock market to put blame. It might be time to go back to school…..behavioral finance 101 might be good place to start!


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