Does Money Make You Irrational?

US News

Even a caveman can do it?

You've probably seen close friends argue over pennies as they dissect a restaurant bill. People are funny about money.

Last week I was discussing this phenomenon with a friend who's in accounting. Her experiences are similar to many stories I've heard from other financial industry colleagues.

Some rich people feel poor. Some poor people feel rich. Money can make people overly secretive. Others want to tell the world how well they're doing. Nice people can get mean about money. Otherwise conservative personalities may decide to take financial risks on a whim, and aggressive personalities may guard their cash with their lives.

The overriding theme is that people can become irrational about money. My accountant friend has clients who expect to beat the tax code. And I hear about retirement investors who expect to outwit the market, never losing money to the bear and always ahead of the bull.

Why are we so funny with our money?

If we were cavemen and cavewomen, hoarding food and periodically taking risks to get more could help our clan survive. Showing off possessions could attract more people to join our group. Becoming protective and secretive around certain aggressors could help avoid pillaging. Precisely dividing shares of food and fairly assigning jobs would help our retention rate, so people would remain happy and not flee to the cave next door.

These behaviors aren't irrational when we look at our ancestry. They become irrational when we apply ancient logic to today's lifestyle.

How can you avoid becoming funny with your retirement money?

Resist the recency bias

The recency bias is the practice of making investing decisions based on very recent performance. Focusing on recent returns without broadly researching an investment could lead an investor to make very poor choices.

Since every good investment has ups and downs, the recency bias could cause you to sell a solid long-term investment during a down time. It could also lead you to put too much of your money into one asset class or sector, so you wouldn't be well-diversified. And the recency bias could lead you to buy an investment at its peak and sell as it drops--buying high and selling low.

Stop selective information gathering

Selective information gathering means seeking statistics and analysis that support a decision you've already made.

It's not difficult to talk yourself into an investing decision you've already made. You'll be able to find positive data about nearly every investment, and you can choose to ignore the bad data.

Seeking information that reinforces your beliefs allows you to feel that you've researched your investment--without the risk of running into information that disproves your beliefs. Selective information gathering doesn't help you learn more or make better investing choices.

Quit counting your retirement savings every day

Obsessively counting and tracking retirement savings on a daily basis can make you feel like you need to take action too often. Since retirement investing is a long-term endeavor, making account changes too often is counterproductive. It leads to worse returns for most retirement investors, and trading fees cut into your profits.

It's reasonable to check your retirement investments on a quarterly basis and in the event of drastic market changes. Just remember not to panic with market changes; stick with your long-term strategy.

Stop acting like a caveperson and adopt a long-term strategy

Don't try to overthink your investments or outthink the market. Create a rational long-term investing strategy for your retirement.

Your strategy should focus on your tolerance for risk, your investing timeline, your personal preferences, and the current economic conditions. Develop a suitable asset class allocation, and then choose the most appropriate investments from the funds available in your retirement plan.

Then stick with your plan, whether the market is up or down. Don't try to beat the market, and don't give in to outdated instincts.

If you need help researching the most suitable asset class allocation and investment choices for your situation, a professional retirement adviser will be able to help.

Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.

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