For Financial Planning Success Consider the Impact of Behavioral Finance
by Keith A. Rhodus on Feb 1, 2018
The success or failure of a financial plan is driven by a variety of possible influences. Factors like the right rate of savings, good investment selection, and careful risk management are all important and commonly recognized as elements of a high quality plan. Going a step further and incorporating a well thought out estate plan can turn a good plan into a great plan.
But what can sabotage a plan? The obvious answers, like not saving enough or poor diversification of course apply. In spite of these apparent risks, financial planning can be like an iceberg, where much of the danger sits below the waterline. It is the hidden aspects of our own decisions that represent a great risk to the success of a financial plan, yet many of us remain unaware of the common flaws in financial decision making that tend to undermine even the best laid plans.
Importance of decision making
When making a financial plan the decisions we make today have consequences that can last for years, decades, or even generations.
Large investment banks and hedge funds are more aware than ever of the importance human behavior has on both short and long term results, and as such are investing in a field of expertise often referred to as “behavioral finance”. While this emerging field of study is broadly accepted as producing some important findings most of us don’t need to spend millions of dollars on the latest research and psychology experts to get positive results. Instead just keep an eye on a few simple decision-making biases and you’ll already be one step closer to making sure you have a sound financial plan that is protected from yourself!
Smart decisions vs. instinctive reactions
Economics Nobel Prize winner Daniel Kahneman’s 2011 best seller “Thinking, Fast and Slow” provides a blueprint of these cutting-edge tips for improving your financial decision-making. Here are a few noteworthy examples to consider in your planning process.
- Overconfidence is common and can put your plan at risk. It’s ok to be optimistic, but it’s dangerous to assume the future will look the same as the past and that what worked before will work again. Circumstances change, sometimes unexpectedly, and it can pay to prepare for possibilities - no matter how remote you think they are.
- We feel the sting of losses more than the joy of gains, meaning that short term portfolio volatility can cause reactionary decisions that aren’t good for our long-term goals. Reviewing your accounts on a daily basis, particularly during periods of uncertainty, triggers our natural instinct to make decisions based on fear. If you have a good plan (and a good planner) it makes sense to check accounts infrequently and keep your eye on the long-term.
- Avoid “confirmation” of what you see the world. Limiting planning conversations to people that agree with our own way of thinking about finances makes it less likely that we consider new evidence and make fact-based decisions. Good financial planners will often challenge our preconceived notions around finances and long-term goals, and this in turn can result in better decision-making.
Addressing the human side of the planning equation is a great step toward improving the odds of your financial plan succeeding. Talk to a financial planner today about how lessons learned from behavioral finance can help keep you and your plan on track.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.
There is no guarantee that the implementation of a financial plan will yield positive results.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2023 Advisor Websites.