When it comes to putting money away, it is crucial to have a financial plan, writes Neesa Moodley-Isaacs
The way in which your brain processes financial information has a huge effect on the way you make investment decisions, says Carl Richards, the author of The Behavior Gap.
“There was actually a study done where they found that when investors see positive results, this information is processed in the same part of the brain where you register pleasurable activity. On the other hand, negative results are processed in the same part of the brain where you register mortal danger,” says Richards, who is also a certified financial planner and director of consumer education for the BAM Alliance.
Speaking at Allan Gray investment seminars across the country last week, he explained that there are four very human mistakes that people tend to make with their money:
When people invest, they tend to tie themselves to one number. This may be either a share price or, for example, the price paid for a house.
For example, you buy a house for R550 000 and then pay R50 000 into the bond over some time. You then decide to sell the house but the estate agent tells you that the house is worth R400 000.“People tend to think, ‘Oh well, I’ll get out when I can break even,’” Richards says.
One of the reasons for this behaviour is that the pain experienced in loss is twice as profound as the joy found from gains.
“If there is a loss in your investment portfolio, ignore it. You have to be able to admit you were wrong,” he says. Richards points out that you could do the “overnight test”. This is where you imagine that overnight you had cashed out all your investments. If you had the money in hand, would you invest it in the same investments again? If not, the question is why are you still holding those investments?
2 RECENCY BIAS
This refers to the mind-set that when things are good, they will be that way forever. Richards points out that a recent investment survey showed that the markets are currently at their highest point in seven years.
However, 90% of investors thought that it is currently a good time to get back into the stock market. This goes against the basic investment strategy of buying low and selling high. If the market is at its highest point in seven years, it could very well be peaking.
So this means that if you invest at this point, you stand to lose money unless you are going to hold the investment over the long term.
“You have to force yourself to lengthen your view of history and remember that things change,” he cautions.
3 CONFIRMATION BIAS
This is a typical male behaviour, Richards says. Often men will make a decision and then actively gather evidence to support their decision while consciously ignoring all information that indicates they could be wrong.
4 PATTERN PROBLEM
This is where investors look for a pattern. For example, “the last time the stock market did this . . .”
If you look hard enough, you will find a pattern in anything, including the stock markets, but this is unreliable and there is no way to predict how the stock market is going to move, says Richards.
Investment behaviour solutions
It is not all doom and gloom. The good news is that if you recognise your “human mistakes”, you can also take steps to correct yourself.
One of the things Richards advises is that you start talking about money. This doesn’t mean you need to go out and tell your neighbour how much money you earn or how much your car costs each month.
“You need to talk about your financial goals, your savings methods and how you plan to achieve those goals. You need a financial plan of action and to get there, you have to talk about money,” he says.
Richards points out that financial stress is the leading cause of divorce and was also attributed as the leading cause of adult male suicide last year.
You need to focus on what is important. In society today, we are faced with an information overload. “Beating an index is not as important
as meeting your own goals. Instead of focusing on the index, look at your goals and examine whether your investment is helping you meet those goals or not,” he says.
Richards advises that you have a financial plan as a starting point. This will help you decide why you are investing the way you are. “A unit trust fund manager is the last step in the process, not the first. You wouldn’t argue about what mode of transport to use before you decide where you are
going, would you?” he points out.
Finally, Richards says instead of spinning around in a circle of worry, you need to examine issues and decide if it is something you have control over.
When it comes to investing, the things that matter are things that you can control, such as your investment behaviour, how much you invest and when you retire. The one thing that is out of your control is the stock market and its ups and downs.
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