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Keep a cool head: 4 tips for avoiding financial mistakes

Instinct often causes people to make financial decisions emotionally—not logically. Understanding how human behavior affects you can help you rise above those emotions to make financial choices that make more sense for you.

Avoid knee-jerk decisions

Michelle Fuller, an employee benefits advisor at Steward Sneed Hewes, a division of BancorpSouth Insurance Services, frequently sees evidence of emotional decision-making. "My clients risk making knee-jerk decisions every time the market goes up or down," she says. By working with a financial professional, you may temper emotion-based financial decisions.

Manage human nature

Countering emotions is challenging, but it's possible. Here are a few ways human nature can get in the way of your financial goals, and tips on how to overcome it:

We're tempted by the near term. Like quitting smoking or sticking to a diet, saving for retirement requires placing long-term benefits ahead of near-term gains. You know that saving for retirement is a rational decision, but it may be hard to put a value on benefits you won't enjoy for a long time.

» Tip: Try to boost your salary deferral contributions each year. Even better, your employer may offer an automatic deferral increase option. Also, avoid impulse purchases. Have the discipline to walk away for a day and ask, “Do I really need that?”

Losses hurt. Many people have a tendency to worry more about their losses than they enjoy gains. This tendency may lead you to accept lower return potential than needed in order to avoid the sting of a loss.

» Tip: Set up a rebalancing plan and stick to it. Review your investment elections periodically to make necessary adjustments, but not so often that you get caught up in every little market flutter.

Having too many choices can be counterproductive. In one study, plan participants who were offered more investment options on an enrollment form tended to choose options with lower-risk and lower potential returns—whether or not they were appropriate to the investors' situations.1

» Tip: Select the appropriate investment mix for you. Adapt your asset allocation plan based on your needs—not the available choices. The Principal® has several resources and tools to help you with this process, starting with the Investor Profile Quiz.

We chase past success. Another study found that the average equity fund investor trailed the S&P 500 by about five percentage points a year during the 20 years through 2009—largely because investors tended to buy more after periods of strong performance.2

» Tip: Try not to obsess about short-term market moves. It's a good idea to keep your eye focused on your ultimate retirement date, not the daily headlines.

Consider Your Future

Millions of baby boomers are getting closer to retirement. Larry Zimpleman, Chairman, President and CEO of Principal Life Insurance Company, the retirement plan service provider, addressed the topic on CNBC’s Squawk Box.

» View the five-minute video on CNBC's Squawk Box to hear Larry Zimpleman's comments on volatility in the markets and some thoughts on lifecycle and lifestyle funds.

Take the Next Step

 

[1]
Iyengar and Kamenica (2010)
[2]
DALBAR, Inc. 2010 Quantitative Analysis of Investor Behavior

Equity investment options involve greater risk, including heightened volatility, than fixed-income investment options. Fixed-income investment options are subject to interest-rate risk, and their value will decline as interest rates rise.

Asset allocation does not guarantee a profit or protect against a loss. Investing in real estate, small-cap, international and high-yield investment options involves additional risk. Additionally, there is no guarantee an asset allocation investment option will provide adequate income at or through retirement.

Fixed-income and asset allocation investment options that invest in mortgage securities are subject to increased risk due to real estate exposure.

Neither the principal nor the underlying assets of our target date funds are guaranteed at any time, including the target date; and investment risk remains at all times.

Michelle Fuller and Steward Sneed Hewes, a division of BancorpSouth Insurance Services, are not affiliated with any member company of the Principal Financial Group.


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