Financial planning… Isn’t that based on cold, hard facts and scientific reasoning? Surely emotions and feelings don’t have much to do with investing?
I think they do. And here’s why.
A little thing called human behaviour gets involved, you see. Only it’s not so little.
Human beings are highly complex systems, stimulated by numerous factors and emotions. This makes us irrational, volatile and unpredictable. We also hold values and beliefs that determine our behaviour; some logical and valid, others not quite so much.
But despite being so significant, human behaviour is frequently one of the most overlooked aspects of financial decision making.
Factors that influence us
Our financial behaviours are influenced in many ways, from sensational media headlines about the next recession or stock market crash to friends down the pub telling us they know best.
You know the type of thing: “It worked for me, so you should do the same.”
Your personal circumstances, your aspirations and the current market could be very different, so it’s important to draw your own conclusions.
Beware of the biases
You may think your decisions are based on sound, rational judgement, and at times they may be, but equally, the framework in which you are making the decision could be distorted. And that’s not useful.
This is where you need to be conscious of bias. It’s all part of what makes us who we are, but it’s not always helpful when making decisions.
We suffer from two common biases that can cloud our judgment and get in the way of us achieving our financial goals:
1. Emotional bias; and
2. Cognitive bias
Emotional bias generally occurs spontaneously and is based on the personal feelings of an individual at the time a decision is made. Cognitive bias typically involves decision making based on well-known concepts that may or may not be correct.
These types of bias can be especially significant in relation to risk. For example, being either extremely cautious or overconfident could each have a harmful effect on your financial well-being.
If you’re an optimist, you may tend to take too much risk, managing your money in a way that may have severe consequences in the future. On the other hand, if you’re risk averse, you may be holding yourself back from attaining true financial independence.
If you’re what’s known as ‘loss averse’, you may worry about losing money to such an extent that you avoid making a loss more than trying to make a gain. So your financial decisions may be motivated by the desire not to lose £2,000 rather than to make £3,000. Such a bias can be strengthened so that the more losses you suffer, the more loss averse you become.
Another common issue is inertia. This may cause you to put off making a decision altogether. Maybe the whole process just feels too challenging. Perhaps you don’t have the time. Maybe you fear making the wrong decision. Whatever the reason, inertia is the enemy of financial security, because it gets in the way of action.
An objective eye
Whether your financial decision-making is being hindered by an inaccurate bias, be that emotional or cognitive, or a reluctance to move forward at all, working with an independent financial planner can help. Our role is to help you make clear, objective decisions, free from clouded judgment. Those decisions could help you secure better financial outcomes, whether that be passing money to the next generation or retiring on your own terms.
So the next time you think of financial planning as ‘disappointing’ or ‘boring’, think of the ‘human behaviour’ component. I think you’ll find it a good deal more enjoyable and emotionally rewarding if approached in this way.
If you’d like to talk over your financial planning in more detail, do get in touch with us. You can call us on 01789 263888 or email firstname.lastname@example.org.
Your capital is at risk. The value of your investment (and any income from it) can go down as well as up and you may not get back the full amount you invested.