When it comes to investing, we humans can't help but get in our own way. In fact, the very traits that have allowed us to survive and thrive as a species can make us bad investors. Let's discuss how mental accounting might be detrimental to financial freedom.
Our brains are pattern making machines, categorizing our experiences and classifying them in a way that is meaningful to our personal narrative. The problem is that sometimes we see patterns that might not really exist, or that can derail us from achieving our financial goals.
We humans ascribe different values to money based on its origin. We often take less risk with money that is earned and are willing to take more risk with money that is won or found. Imagine that you are a finalist on a gameshow and have earned $10,000. You're now faced with a decision; you can risk the $10,000 on the flip of a coin and if it's heads you get $20,000 and tails you get $0. What if you have the same opportunity to bet your paycheck on the flip of a coin; what would you do?
Most of us are not willing to risk our paycheck because we think about money earned differently than money won. Many casinos are in business because of this principle!
Moreover, the way we approach risk impacts our investment decisions. Deciding how much risk to take in your investment portfolio involves analysis of several important factors including: your goals, time horizon, and appetite for risk. Even the most carefully crafted portfolio can wreak havoc on your financial plan if it's not aligned with your risk target.
Nicole Gopoian Wirick JD, CFP® is the President of Prosperity Wealth Strategies, a business she founded to focus on providing a high touch, concierge style approach to financial planning. Call today to explore how she can help you achieve prosperity.