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3 Ways Your Mind Tricks You Out of Building Wealth
Solid Strategies for Building Wealth ... Avoid These Mental Pitfalls
Careful and diligent planning over time is a reliable strategy for building wealth, but did you know that your mind may be working against you and your long-term plans? There are a number of mistakes that people make in their financial decisions that can throw off their wealth strategies. Hereâ€™s a quick guide to ways that your mind can trick you into making poor financial decisions:
Anchoring: Donâ€™t fall into the trap of relying too much on the first piece of information you learn about something. For instance, pretend you are interested in hiring a housecleaning service and you begin to call around to check rates. The first company you call quotes you $75 per hour. The second company gives you a rate of $90 per hour.
You may dismiss the second company because they are charging $15 more per hour and go with the first company instead. In fact, though, the going rate in your community is $60 per hour, but you overpaid because of the anchoring fallacy.
How do you get past anchoring if you donâ€™t have endless hours to call cleaning companies and compare every rate out there? Some experts recommend that, instead of trying to get a true average rate, you estimate how many hours youâ€™d have to work to cover the cost of a service or product, or what else you will have to give up to purchase it. This might help you get a truer sense of your cost.
One particularly strong anchor in investing is a stockâ€™s price. Investors tend to keep their purchase price at the forefront when making trading decisions. For example, if you buy a stock at $10 per share and itâ€™s currently trading at $8 per share, you may hesitate selling the stock because itâ€™s lower than your initial purchase price. But what if the stock was overvalued when you bought it? Anchoring is often responsible for investors selling winners too soon or holding losers for too long.
Availability Heuristic: In this financial misstep, you pay more attention to more publicized events over those that are most likely to actually happen. For instance, you may have an outsized anticipation of winning the lottery because instances of lottery winners shown on the news stand out in your mind.
This concept carries over to other areas in life, too. You may have sweated a little on a trans-Atlantic flight, but probably not on your drive to the grocery store. Despite the fact that traffic accidents are far more likely than a plane crash, you brain latches on to news stories youâ€™ve seen about flights that ended in crisis.
Likewise, an investor tends to overreact to the â€śtalking headsâ€ť on the radio or television who warn of doom and gloom in the markets.
Hedonic Adaptation: When you purchase something new, you often feel a rush of satisfaction and excitement. In some cases, such as with a new car or a dream home, you may feel unable to contain yourself as you bask in the glow of acquisition. Even a new pair of shoes or a weekend trip can make you feel like you could never ask for anything more.
The trouble is, you always do, and itâ€™s keeping you from building wealth. The hedonic adaptation principle says that no acquisition is capable of satisfying you forever. Whatâ€™s more, you become less willing to go back to your previous lifestyle, even though your new purchase isnâ€™t satisfying you like it did when it was new.
Overconfidence: Overestimating your own ability, at choosing investments, for example, can be detrimental to your financial strategy. If you donâ€™t have the time, expertise and experience to handle an investment portfolio, consider hiring an investment advisor to help.
Hindsight: Weâ€™ve all heard it: â€śhindsight is 20/20.â€ť When analyzing past events, itâ€™s easy to hinge on information that hadnâ€™t been available at the time, believing that the event was predictable (and perhaps preventable) when it really wasnâ€™t. For example, after a stock market crash, you suddenly think of many reasons why youshould have adjusted your portfolio more conservatively, when in reality, there was no way of knowing it was coming. (Interestingly, hindsight can lead to overconfidence, as well.)
Building wealth over time takes a lot of discipline, but it also takes an awareness of the tricks your mind might play on you as you make financial decisions. No matter how solid your wealth strategies are, be careful that you arenâ€™t derailing your goals by buying into these fallacies.
To learn more practical ways to think about building wealth, make an appointment to talk with the advisors at Family Investment Center. Always commission-free and client-focused, we help you develop strategies that are clear-minded and designed to help you plan for a solid future.