Posted on Thursday, March 17, 2011
Instinct often causes people to make financial decisions emotionally—not logically. Understanding how human behavior affects you can help you rise above those emotions to make financial choices that make more sense for you.
Avoid knee-jerk decisions
Michelle Fuller, an employee benefits advisor at Steward Sneed Hewes, a division of BancorpSouth Insurance Services, frequently sees evidence of emotional decision-making. "My clients risk making knee-jerk decisions every time the market goes up or down," she says. By working with a financial professional, you may temper emotion-based financial decisions.
Manage human nature
Countering emotions is challenging, but it's possible. Here are a few ways human nature can get in the way of your financial goals, and tips on how to overcome it:
We're tempted by the near term. Like quitting smoking or sticking to a diet, saving for retirement requires placing long-term benefits ahead of near-term gains. You know that saving for retirement is a rational decision, but it may be hard to put a value on benefits you won't enjoy for a long time.
» Tip: Try to boost your salary deferral contributions each year. Even better, your employer may offer an automatic deferral increase option. Also, avoid impulse purchases. Have the discipline to walk away for a day and ask, “Do I really need that?”
Losses hurt. Many people have a tendency to worry more about their losses than they enjoy gains. This tendency may lead you to accept lower return potential than needed in order to avoid the sting of a loss.
» Tip: Set up a rebalancing plan and stick to it. Review your investment elections periodically to make necessary adjustments, but not so often that you get caught up in every little market flutter.
Having too many choices can be counterproductive. In one study, plan participants who were offered more investment options on an enrollment form tended to choose options with lower-risk and lower potential returns—whether or not they were appropriate to the investors' situations.1
» Tip: Select the appropriate investment mix for you. Adapt your asset allocation plan based on your needs—not the available choices. The Principal® has several resources and tools to help you with this process, starting with the Investor Profile Quiz.
We chase past success. Another study found that the average equity fund investor trailed the S&P 500 by about five percentage points a year during the 20 years through 2009—largely because investors tended to buy more after periods of strong performance.2
» Tip: Try not to obsess about short-term market moves. It's a good idea to keep your eye focused on your ultimate retirement date, not the daily headlines.
Consider Your Future
Millions of baby boomers are getting closer to retirement. Larry Zimpleman, Chairman, President and CEO of Principal Life Insurance Company, the retirement plan service provider, addressed the topic on CNBC’s Squawk Box.
Take the Next Step
• Log in to principal.com any time to review account information.
• Check out the retirement planning calculator to help discover your retirement goal, determine if you're on track and draft a retirement guide personalized to your situation.