- After five years of studying people at opposite ends of the wealth spectrum, I was able to identify behavior patterns that lead to bad money decisions.
- Those patterns include letting ego drive your money decisions, allowing emotions to get in the way of your choices, over or under-thinking your financial decisions, and making decisions out of fear or stress.
- Just like anything else, making poor money decisions that stand in the way of building wealth can become a habit, so it’s wise to get in front of them as soon as possible.
- Need help making better money decisions? SmartAsset’s free tool can help find the right financial planner for you »
In my Rich Habits research, I spent five years interviewing and studying people at opposite ends of the wealth spectrum: 233 people with at least $160,000 in annual gross income and $3.2 million in net assets, and 128 people with less than $35,000 in annual gross income and less than $5,000 in liquid assets.
As I peeled the onion, I learned a lot about how people manage their money, and why so many people have money problems.
Thanks to my research, I learned that bad money habits can be sourced to 12 very specific money mistakes — which are grouped here into four types — that stand in the way of building wealth:
1. Letting your ego drive your financial decisions
Ego-driven money decisions prevent you from managing whatever money you do have in a prudent manner. Some of the specific examples of this from my study included buying expensive things intended to create the perception you’re doing better financially then you actually are, feeling invincible (this was one of the reasons many people do not purchase adequate life insurance), and thinking you’re smarter than you actually are — this is one of the reasons why the people I studied didn’t hire experts or seek feedback from experts, and took risks without doing their homework.
This type of decision is closely related to another: externalities — letting outside factors decide what you do with your money. Keeping up with the Joneses’ spending decisions is an example, as is pressure from a spouse, family, friends, or work colleagues.
2. Allowing your emotions to get in the way
Spending decisions that are based on spur-of-the moment emotions almost never go well. The same goes for making spur-of-the-moment purchases, which could be related to emotion-based spending mistakes, but could also be caused by decision fatigue. For example, you receive a big bonus or a big raise and, in the heat of the moment, you find yourself at a car dealership purchasing a brand-new luxury car.
3. Embracing ignorance — or overthinking your choices
Operating from a place of ignorance — not doing your homework, whether that’s ego-based or for some other reason — or overthinking your choices are opposite ends of the spectrum, but both can lead to damaging mistakes.
Making decisions out of impatience is also a bad move. For instance, liquidating investments during a downturn in the market can be fear-based or driven by a lack of patience. Making any major purchase without wanting to spend the time doing your homework (ignorance), is another example.
Simple solutions are usually the correct solutions. Seeking more complicated solutions leads to chaos.
4. Making decisions out of fear or stress
Never make money decisions out of fear or stress — again, consider the bad move of liquidating long-term investments during a stock-market downturn. Studies have shown that stress reduces your IQ by 13%. Never make money decisions when you are under stress, if you can help it.
A closely related cause for poor decisions is desperation — decisions made from a position of weakness. They are typically the result of prior bad decisions and always forced upon you by some third party, such as a lender, government agency, credit card company, employer, spouse, family, or friends (externalities).
Once you start making frequent poor decisions, it can become habit just like anything else. It’s best to understand what drives those bad decisions in the first place, which can help you avoid making them in the future.
Thomas Corley is the author of “Rich Habits: The Daily Success Habits of Wealthy Individuals,” and “Rich Kids: How To Raise Our Kids To Be Happy And Successful In Life.” Follow him on Twitter.
Need help making better money decisions? SmartAsset’s free tool can help find the right financial planner for you »
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