Personal financial success is greatly improved by knowing and regularly reviewing one’s capabilities, goals, and financial situation.
Too often, we meet with prospective clients who have mismatched financial strategies. By that, I suggest their investing strategy is out of sync with their risk tolerance and goals. Why does that occur? Experience tells us, there are three primary reasons:
- Infrequent and inaccurate assessments of their financial situation and goals.
- Behavioral biases: Mistaking what they feel, hear, or think for facts and knowledge?
- Fundamental gaps of knowledge about specific financial areas such as market behavior, tax implications, and investment selection.
This article addresses #2 on the above list – Behavioral Biases. Typical mistakes include making investment decisions expecting the near future to be similar to the recent past; investing aggressively but disregarding your upcoming cash needs (i.e. home down-payment or paying off credit cards); selecting the wrong type of IRA; and obsessively watching the markets.
It’s also very common, and perhaps even innate, to rationalize poor past decisions. To help understand the power of rationalization, let’s flashback to 1962, when the original Beatles drummer, Pete Best, had been replaced by Ringo Starr before the band’s first world tour. Asked how his life had unfolded after the shake-up, Pete Best responded, “I have no regrets.” That is remarkable rationalization. On the other hand, perspective can soothe the (rubber) soul.
Of course, it is helpful to recognize when financial behavioral biases have crept into your thinking. A good place to start is simply questioning why you believe what you believe. Are your beliefs or knowledge founded on study, research, experts, cocktail party conversation, a rerun of Seinfeld? Further, be aware of common biases that impact the clarity of your decision-making. These include:
- Recency Bias: Attaching greater weight to recent events.
- Overconfidence: Being over-confident in one’s decision-making ability in a random world.
- Anchoring: Having attachment to past value.
- Political Bias: Overstating the impact of political events.
These biases, and how to successfully address them, are thoroughly discussed by my colleague, Brian Gongaware, CFP®, in the video Understanding Behavioral Bias. It’s worth your time to watch.
Ultimately, successful financial planning and investing go hand-in-hand for most investors that seek to use all or part of their portfolio for their needs or to support their family, at large. As such, it is critical to have good information (aka, a true assessment) and be free from any pre-conceived notions and blind spots that might impair thoughtful decision-making.
To read more on assessing your current situation, read Why 'Assessment' Should Become Your New Financial Habit.