I meet a lot of people highly qualified in their own field of expertise, clients that are scientists, doctors, bricklayers, electricians, awesome administrators, experts in organisation and efficiency, educators and amazing carers who either have little people to grow or elderly people to comfort and be companions to.
Many that I meet are making decisions, and so the psychology of decision making is something that I’m deeply interested in so that I can support people to make excellent decisions that they feel confident with and that meet both immediate and long-term ideals.
We are, unconsciously influenced by our past experiences, the people around us and new information. The difficult part is to sift through this recipe of decision making to understand these biases (call them hang ups) and the influence of our friendships and family (following the lead of others), or other groups that we participate in (social groups, interests) to take note of crowd behaviours.
The question to focus on is. Am I being rational about this, or am I letting those other powerful and emotional expectations change my view?
Another interesting aspect of decision making is about our perception of risk.
Research tells us that inadvertently the smaller our nest egg, the less risk a person may feel. As the stakes increase, we care more. This can be especially relevant when we are discussing investments as the bigger we have grown our nest egg we can overreact or focus more heavily on the risks even when statistically they may be the same, but amplified as the scale has increased.
It’s about managing risks and what is really underneath those risks
- Accidents – What if I stuff it up completely with an error?
- Worry – Am I being overly emotional, and worrying myself when more information could reassure me?
- Loss aversion – I am heavily focussed on the loss, and less worried about what I might gain.
- Bad behaviour – I am making decisions that may make things worse because I’m overreacting, (would you still sell your home if the value of it dropped by a third in a month? Or would you wait?)
- Over confidence, (this is that sneaky feeling, fear of missing out)
- Gamblers fallacy (If I won last time, I’ll win every time)
- Confirmation bias (seeking out only the news and stories that reinforce a decision you like)
- FOMO (Fear of Missing out, means that you may overcommit to a concept with too much confidence, Bitcoin when it peaked?
- Availability bias (This option is the only one that I have found, I’ll do this in the absence of looking for an alternative)
But let’s take a peak inside that nest egg to check out some of the options to build in some strategies to reduce the risks of these biases.
- What is it?
Choosing to spread your decisions out over many smaller decisions or parts so that no one part or no one decision has the power to upset the overall outcome adversely, instead you get the average of the outcomes of all of the smaller parts instead.
- Why can it help?
In investments, diversification can mean, diverse strategies, (different tax treatments for different strategies), different assets like shares, and property and cash and fixed interest being blended together to average the results overall without the specific risk of one asset group, blending together different companies for the shares portion or different types of property so that no one company is focussed in your portfolio to expose you to single asset risks, spreading investment decisions across geographic locations so that no one location or currency has the power to upset your overall outcome by specific issues only present in that area (Brexit anyone?)
- Will returns still have periods that are negative?
Yes, it is absolutely expected that even with a high degree of diversification, negative returns can still happen but due to the degree of diversification, you should experience less serious negative returns. The trick here is to not fall into the trap of ‘Bad Behaviour’ selling everything in a negative market ( all the good quality investments). Instead, the best outcomes are those that had a plan for volatility, to draw on safer investments during these times for planned drawdowns and to hold the good quality assets that are changing in price for the future as and when they can recover, because a good quality company or property, will generally recover after the noise has died down.
- Whats the downside?
Diversification does average your returns, so over time you may not achieve the concentrated performance of a single asset.
Have a plan B so that you don’t need to draw down or sell great quality assets when markets are in a state of worry/fear.
How? – Set aside a portion of your investment nest egg into a ‘reserve’, we help with this by carefully selecting investments that meet the brief of being less volatile to serve this role.
Have a plan? – Consider the monies you may need in the short to medium term so that we can work with you to appropriately set aside that reserve for the planned drawdowns.
Plan for emergencies/ back up fund? – What would you lean on first if a lump sum expense popped up? Talk about it, have a plan. Ask for help/support from your trusted adviser
For this reason, we do not charge an hourly rate for phone calls, emails or questions for our clients – we prefer to work with you over longer period. Being available to help you and support you as your decision-making environment (climate) changes.
Climate change in finance can be changes to your situation from changing tax rules, wages increase or decrease, social security rules, assets and income tests, aged care rules, politics, market sentiment, volatility and even a crazy tweet that is a bit irrational.
Talk to us about your nest egg and the risks you face now and those that you are worrying about for the future.