You’re surely familiar with the phrase the fruits of your labor; something good that results from your hard work. Perseverance and hard work are necessary ingredients for achieving good outcomes, but behavior deserves the top ranking.
When you combine good behavior with good choices, abundant fruit follows. Without good behavior, good choices might not be enough.
But what does good behavior look like within your financial life?
WHY BEHAVIOR MATTERS
Classical economics teaches that you and I are rational actors which means we think, assess, and then act. Research done over the past three decades in behavioral economics has largely demonstrated the opposite – we act and behave emotionally, but justify the choices rationally.
Some of the most insightful research in behavioral economics has been done by Professor Dan Ariely at Duke University. In a recent interview, he said “Sometimes the best way to get to your long-term interests is to not let your short-term interests participate.”
Investors are naturally irrational. Your biases and preferences percolate to the top of your decision-making process. The problem is these biases are usually invisible so you don’t even recognize that they exist. The bigger problem is that you tend to be “predictably irrational” as Dr. Ariely says.
The good news is it’s possible to train yourself to act more rationally. However, there’s no one-size fits all remedy. The central theme to remember is things that tame your emotions contribute to your ability to behave rationally.
Incessantly worrying about the stock market, interest rates, and inflation is a good example of priming your emotions for irrational behavior. As I wrote about recently in Media Manipulation the financial media specializes in keeping your emotions keyed up. Remember, act on your plan; don’t react to events.
HOW TO AVOID BEHAVIORAL TRAPS
Achieving good long-term financial outcomes has little to do with timing the market or predicting economic trends. Rather, accomplishing your most important goals has everything to do with allowing your financial plan to stay in place long enough to work.
It’s crucial that you visualize financial life more broadly than just investing. Otherwise, negative news can create a strong gravitational pull for you to react.
Your financial life isn’t just digits on a spreadsheet – it’s a bunch of emotions wrapped up in those digits. If you’re always trying to mathematically optimize your portfolio, you aren’t considering your emotions. Will you really be able to stay invested in difficult markets if you optimize your investments? Instead of seeking to maximize/optimize, you should aim for a realistic strategy that can withstand the constant pull of your emotions.
How you make financial decisions is important; how you act and behave after the decisions are made is even more critical. Start there.