July 19, 2019

5 Behavioral Principles to Master for Financial Success

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I believe that if you are able to focus on what you can consistently control, develop a plan around those things, and stick to the plan over the long term; you will sleep better and have a better chance of reaching your financial goals. You and I cannot control the stock market, the economy, or major world events, but by focusing on our mindset, we can have a level of control over our investments. My Five-by-Five formula for reaching your financial goals includes five behavioral and five technical principles. Today we will look at the first five things you can control—the behavioral principles.

Many People Focus on the Wrong Things

I have learned that many people focus on the wrong things when putting together their savings and investing plan. Some common mistakes are:

  • Having a plan that does not fit their unique financial situation and goals. Often, they simply do what the crowd is doing.
  • Not having SMART goals, which are Specific, Measurable, Achievable, Realistic, and Time-bound. No need to overanalyze, but thinking through goals, writing them down, and having some parameters attached to them increases the odds of success.
  • Setting an unrealistic target rate of return as their primary focus. A financial plan should start by identifying goals, not rates of return.
  • Trying to time the markets based on things such as economic forecasts, earnings reports, and political events.
  • Not understanding their risk capacity and risk tolerance. See The Importance of Knowing Your Risk Capacity.
  • Making a high-risk bet by putting all their money into the stock of one company or a single business venture.
  • Wanting to get rich quick without understanding that most people can build enough wealth over a lifetime by consistently investing and saving.
  • Focusing too much on the 24-hour news cycle and making emotional decisions based on it.
  • Getting lost in the weeds while forgetting to focus on the big picture.

The Five Behavioral Principles

A person’s behavior is likely the single most important factor that will determine whether they succeed or fail at reaching their financial goals. I believe understanding and managing the five behavioral principles below are crucial to reaching financial goals.

1. Control Emotions

Bailing on a financial plan and selling investments when markets go down is a sure-fire way to fail at reaching financial goals. The same can be said when markets are rising—many people become afraid they will miss out on huge returns so they increase their exposure to equities without regard to their risk capacity and risk tolerance.

2. Have Patience

Understanding that reaching financial goals takes time and is not achieved overnight is crucial to succeeding. People who want success quickly tend to take on too much risk. Then when something goes wrong, they bail on their financial plan.

3. Have Faith Grounded in Knowledge

One must have faith in the future to successfully invest and save. When an investor purchases shares in an asset such as a mutual fund or ETF, they must believe in capitalism, believe companies will grow and earn more money in the future, and believe our country will thrive and prosper. This faith must be grounded in knowledge about how the markets and economy works. You do not need to get a college degree in finance or economics, but understanding the basics will help you stick to a plan.

4. Have Discipline to Stick to a Plan

A financial plan is a road map for reaching financial goals. For a plan to work, you must stick to it in market ups and downs, year in and year out. This is not to say a plan is never adjusted. However, adjustments should be made deliberately and based on reason and thought, not emotions.

5. Pay Yourself First

This might be the most important behavioral principle and one of the hardest to implement. In order to build wealth, you must live on less than you earn. It is as simple as that. To live on less than you earn, you must set aside a portion of your earnings every time you are paid. The trick is that you have to treat it like your most important bill and make the payment to your savings as soon as you are paid. A mistake that many people make is to wait until the end of the month and plan to save whatever is left over. The problem with this approach is that for most people, there will never be any money left over at the end of the month because they always find a reason to spend it all. See Quick Answer #2 – What does pay yourself first mean?

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