If you are someone who makes New Year's financial resolutions and often doesn't keep them, behavioral economics can help. Behavioral economics studies psychology as it relates to economic decision-making. Ideally, people would make the financial decisions that are appropriate and will benefit them the most.
In economics, the rational choice theory states that when presented with choices under scarcity, people will choose the option with the most personal satisfaction. However, scarcity is an economic problem that is the gap between our financial resources and wants. Scarcity requires us to decide how to use our financial resources efficiently, but often that may differ depending on our choices.
That's where behavioral economics comes in. Sometimes we make rational decisions, and other times, irrational decisions about our financial resources. Here is a few examples of behavioral economics, rational, or irrational decision-making when it comes to our finances:
- Budgeting- buying a coffee shop latte twice a week versus daily spending, which is more than your budget allows.
- Debt- paying off credit card debt and not using credit versus making payments but accumulating more monthly debt.
- Investing- consistently investing each month versus occasionally investing, depending on market performance.
- Herd mentality- spending and investing based on your financial situation versus spending and investing in keeping up with your peers.
When it comes to keeping New Year's financial resolutions, understanding behavioral economics may help you make confident financial decisions in the following areas:
Personal debt- Working toward eliminating personal debt such as credit card, auto, or other personal loans.
Investments- Determining appropriate investments for your goals, risk tolerance, timeline, and situation.
Retirement Savings- Regularly contributing to your retirement savings accounts and maximizing contribution amounts based on your age and timeline until retirement.
Insurance- Reviewing, updating, and purchasing insurance coverage for your situation to offset the risk that can derail your financial goals.
Money Management- Develop a monthly budget to help you understand your cash flow and where you can make objective improvements.
Seek investment help- Working with a financial professional for comprehensive financial planning and working toward it.
Behavioral economics is the psychology that can help you be mindful of the consequences of your financial decisions in the New Year. Start by writing down your financial resolutions, thinking about them, creating your plan, working toward them, and revising. It may help to discuss your financial resolutions with an accountability partner, such as a spouse, close friend, or financial professional.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
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