Saxo Group
Summary: When money is on the mind, it can evoke sensitive feelings in us all. The key to maintaining a healthy relationship with your finances is to recognise and manage your emotions. Surrendering to them can potentially damage your returns and delay your ability to reach your goals.
A 2018 study published in the Journal of Financial Planning found that investors who invest without showing any emotion saw better returns over a longer period of time.
Combining multiple goals into one plan designed for your goals and risk tolerance can be essential to your long-term investing success. Because of our emotions, people tend to attach different values to money depending on where it comes from, or what they want to use it for. This may lead to poor decision-making.
For instance, some individuals spend money from a tax refund faster than they’d spend money they’ve saved diligently for years. That’s because a tax refund is seen as a windfall, even though it’s actually a reimbursement of money that you actually overpaid.
We call this phenomenon “mental accounting”. It explains that people classify money differently based on subjective criteria, which often leads them to spend irrationally, or make financially counterproductive investment decisions.
For example, an investor who sets up two investing accounts – a “safe” one that is overly conservative and a “speculative” one that takes outsized risks – might create a “worst-of-both-worlds” situation with hobbled growth potential and increased volatility.
The Pros and Cons of Mental Accounting
Pros
1. Having specific ambitions in your life can be a potentially positive form of mental accounting.
2. Mental accounting encourages you to seriously think about the goals you’re trying to achieve.
3. It can be comforting and bring structure to your financial life. It can feel intuitively right.
Cons
1. Splitting your monthly contribution between goals could lead to overfunded or underfunded goals.
2. Moving money from less important goals to more important ones requires both mental and emotional effort, especially when you have an unrealised loss in the less important ones.
3. Your emotions could get in the way of defining the right risk to achieve a goal.
How to solve for the pros and cons of mental accounting
With SaxoWealthCare you can merge all your goals into one account, and still enjoy the comfort of defining multiple goals. At the same time, you do not need to worry about over (or under)-funded goals and how to allocate your monthly contributions between your goals. We take care of that by allocating your money so that the feasibility of reaching all your goals – whether they are very important or less important – is maximised at all times.
Of course, no system is infallible and losses can always take place when you invest – even when you exclude your emotions. So during times of market turmoil, if negative returns jeopardise the achievability of your goals, the digital assistant within SaxoWealthCare will help you to get back on track.
To learn more about SaxoWealthCare, click below:
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