How Personal Loans Impact Financial Behavior And Decision Making
It is essential to understand the concept of financial behaviour and the ways in which it impacts your decisions.
Your monetary decisions can have a massive impact on your ability to fulfil all your life goals. In making your dreams and ambitions come true, personal finance plays a crucial role. Thus, it is important to keep a check on how you manage your finances and make wise decisions to uplift your quality of life and standard of living. In order to do so, it is essential to understand the concept of financial behaviour and the ways in which it impacts your decisions.
What is Financial Behaviour?
In simple terms, the patterns and ways in which a person tends to handle their finances are known as financial behaviour. Individuals make financial decisions as per their psychological biases, be it to invest in a mutual fund or to apply for a personal loan. These behaviours tend to have a massive impact not just on personal finances but also on macro levels like the share market. Herein, the sudden rise and drop of stock prices can be attributed to the investors’ financial behaviour.
Factors That Account For an Individual’s Bad Financial Behaviour
We don’t always act in our best interests and take decisions that don’t benefit us. However, improving your financial behaviours can help you reach your set monetary goals in life. All this starts with identifying the problem. Here are five concepts that broadly cover the scope of bad financial behaviour:
1. Mental Accounting
Mental accounting is the tendency of an individual to opt for a specific kind of financial service as per their preference. For example, if you are someone who does not prefer high-risk investments, then you will probably avoid investing your money in equity funds.
2. Herd Behaviour
Herd behaviour is when a person is influenced by the financial decisions made by a majority of people. A good example of this is the stock market. When you see multiple people buying shares of a particular company, you do the same. This is because you assume that the investment is comparatively safer and profitable as multiple people are opting for it.
3. Emotional Gap
When faced with rough circumstances, it is natural to fall prey to fear and anxiety. Taking a financial decision powered by emotion can lead to some very bad situations. An emotional gap is when your fear impacts your rationality. For example, in case of an emergency, you may have availed a personal loan without any research. This can lead to your personal loan EMI putting a burden on your monthly finances.
4. Anchoring
Anchoring is when an individual is fixated on a target number and bases their decisions according to that value. For example, a used car’s offered price sets the benchmark for the negotiation. Herein, when the rates are lowered from the initial offer price, the illusion of a good deal is created. However, the price may still be higher than the car's present market value. As a result, you may end up buying the car at a higher rate.
5. Self-Attribution
Sometimes, one tends to become extremely dependent on their own knowledge where they fail to conduct enough research. Such biased decisions can lead to excessive losses or even result in a profit. However, self-attribution is quite unreliable and thus one must steer away from it.
How To Improve?
It so happens that we may be influenced by popular opinions or circumstances that we may end up making the wrong financial decisions. Solving this is easy. By adopting certain practices and methods, you can improve your financial behaviour by leaps and bounds, like:
1. Budgeting
Nothing prepares you for unforeseen circumstances like budgeting. Understanding and analysing your own financial situation can help you identify the problem areas in your spending. This in turn, allows you to strategically plan your monthly finances.
You can adopt the 20-30-50 rule for better management of your funds. Under this, 50% of your income is used for sustaining your living expenses, while 30% is aimed towards debt repayments. Meanwhile, the remaining 20% make up for your savings.
2. Saving
Save whenever you can. Use the 50-30-20 rule mentioned above to do so. Deposit your savings in a separate allocated account that you can access easily. Continue adding to this account in a disciplined and consistent manner. Set definitive short-term and long-term goals and save up to meet these targets.
Meanwhile, you can invest and try to multiply your idle money. Ensure to make investments of different forms, like stock markets, mutual funds, real estate, gold, bonds, and even fixed deposits, to grow your funds considerably. This increase in your finances can strengthen your monetary safety net, allowing you to get through difficulties with ease.
3. Debt Management
Did you apply for a personal loan without proper research and are now facing its impact on your monthly finances? Learning how to manage your debt is crucial to being financially stable. Always compare the terms of your loan, like the interest rate, tenure, and loan amount, prior to getting a loan.
However, if your existing personal loan EMI has started straining your finances, opt for options like prepayment, foreclosure, or balance transfer. Make sure to pay your credit card bills on time to avoid paying extra interest charges. Opt for automated payment options, where money is deducted from your account directly and sent to your lenders on a fixed date every month.
4. Avoid Impulse Purchases
We all enjoy purchasing items we don’t really need on impulse. It is okay to indulge in such spending once in a while; we can’t always give in to our temptations. Curbing your small and big expenses can lead to a huge difference in your personal finances. A great way to control your impulse purchases is to wait for 24 hours after having the urge to buy an item. This gives you enough time to rethink. If you feel that buying the commodity is absolutely necessary after 24 hours, make the purchase. This method helps control your urges and think about your spending with a clear mindset.
5. Emergency Funds
In moments when fear and anxiety are at their maximum, we tend to make decisions that are not favourable. To avoid such circumstances, it is essential to be prepared for unwarranted situations like sudden hospitalisations and so on. In such cases, we may panic and apply for a personal loan without conducting the required research or negotiating the loan terms
However, if you have an emergency fund, which is easily accessible to you, then you can manage such emergencies much more efficiently. It is important to have an emergency fund in the form of a cash reserve or assets that can be easily liquidated like gold. This ensures that you are financially protected in distress and have one less thing to worry about in a time filled with difficulties.
Your financial behaviour, if bad, can be improved quite easily. Just follow the aforementioned steps and walk on the pathway to financial stability. Seek the help of a professional like your financial advisor for expert opinions and strategies to manage your money better and fulfil all your monetary goals. Break free from bad behavioural patterns and make wise monetary decisions to fulfil all your financial obligations with ease.
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