Savers and investors are often their own worst enemy when managing their money because false obstacles stop them from making the right financial decisions.
The insight comes from behavioural psychology studies of investors with self-managed pensions in the United States, but equally apply to retirement savers in other countries.
Here are some of the points the psychologists observed:
Loss or risk aversion – Many savers are more afraid of losing money than making a profit and fall short of their target for retirement because they miss out on investment opportunities. These savers should set fund targets and switch investments to maintain performance.
Endowment effect – This happens to savers who like an investment too much and keep it in their portfolio long after the sell by date. They should become more ruthless and let a fund justify inclusion rather than develop a soft-spot.
False accounting – Assigning different rules to savings made for different reasons, like holiday money, pension savings and personal savings. The rules seem reasonable but are not logical – for instance reducing a pension contribution to save for a holiday only to miss out on the employer’s contribution that tops up the pension amount.
Bad data – Basing decisions on wrong or misinterpreted information, often taking advice from third parties instead of directly accessing information from a professional
Overconfidence – Several polls show 80% of investors rate themselves as ‘above average’, leading many not to take professional advice when they should
Naïve diversification – You have 10 funds in a SIPP and divide the contribution equally instead of considering risk, age and performance, which is rarely a good investment strategy.
Buy high, sell low – Fear on missing a once in a lifetime chance means investors are more likely to buy funds or equities on the rise than those performing less well.
Most of these problems come from investors in a bubble failing to take advice from a professional.
Consulting an IFA might come with a price tag, but often the price is worth paying if you are inadvertently falling into some of these financial traps.
After all, they could be costing you as much or more than you might spend on taking advice.