Some unconscious biases may be influencing you as you make decisions about your financial investments. Even if you recognise and accept that their powerful influences are at work, the very nature of the beast presents a problem. They’re not only influencing you unconsciously, but biases such as over confidence in our own ability and an inability to see our own failings, making them difficult to avoid. Difficult but not impossible.
A little understanding of what’s at work can go a long way, both in how you respond to your own instincts and how you respond to external information. An investment that is being sold to you on the basis of its great performance over the last three years, takes no account of your own particular financial objectives (which might be x% growth over a 20 or 30-year period, for example). Neither does past performance alone predict future performance. It doesn’t necessarily take into account how high a risk the investment presents. In fact, this kind of sales pitch just taps into your instinctive “greed or ambition” bias, your fear of losing out and maybe even your instinct to follow the crowd. Recognising what’s at play enables you to detach from the emotional pull of what at first glance looks like a tempting, high performing opportunity.
Recognising what’s at play enables you to detach from the emotional pull of what at first glance looks like a tempting, high performing opportunity.
As part of planning your portfolio psychometric assessments really can play a pivotal role in reducing the risk of impulsive or emotional investing. An assessment can unveil not just your ability to withstand a measure of financial loss, but also any biases that may be at play – such as unrecognised overconfidence, an overzealous desire for gain, or an overdeveloped sense of fear. These insights (which should be seen as natural rather than negative) don’t just help your financial adviser as they recommend the best investments for you. They help you get a better understanding of what makes you tick and what has the potential to derail you.
Clear objectives and a life plan
It’s really important that you have a financial plan which is anchored to clear objectives and supports your life plan. Knowing that you have invested for the next 25 years with the hope of achieving x% growth – that will provide you with the retirement lifestyle you’d love, making it easier to ignore the pull of a short term financial storm. Particularly if your financial adviser is able to reassure you that your investments are still on track. In identifying your objectives, it’s also important to think about life plans as well as financial objectives. That’s part of our expertise, and we don’t think you can properly plan one without the other. A combination of the two also creates a much stronger and visual aid to hang onto in the event that you’re tempted to react to a sudden market event.
An independent hand on the tiller
Even with the best laid plans it can and will be tempting at times to give in to unconscious bias and this is when an independent financial adviser comes into their own. In fact, they become your financial planner. Stuff happens, markets (and at times, entire economies), collapse and the role of your financial planner at that point, is to make sure these events don’t derail you.
It’s really important that you have a financial plan which is anchored to clear objectives and supports your life plan.
Rely on the evidence
Which brings us neatly to how important it is to accept the market for what it is. It will involve losses as well as gains. Investing is not a get quick, overnight solution. If you’re trying to beat the markets, you are almost certainly going to lose. Investing is a long game – there is a vast body of evidence compiled over the last 50 years that shows that the key to successful investment is based on a number of “sensible” factors:
- Investing in low cost investments,
- Investing in a diverse portfolio, so that you spread the risk,
- Investing in a way that takes into account your attitude and ability to sustain loss,
- Investing for the long term so that any short-term issues become less important against a background of long term, overall growth.
Unconscious bias will always be at work. It’s part of who we all are and helps us to function efficiently in many circumstances. It is important to recognise it for what it is and accept that it is operating, usually to your detriment, when it comes to your finances. It’s a dangerous strategy that chooses to ignore unconscious bias but a few carefully considered measures will help you from making common investing mistakes.