Is Your Brain Making Bad Investment Decisions?

Jul 6, 2014 Willow Creek Wealth Management Posted in Articles, NBBJ

Originally Published in North Bay Business Journal As financial advisors, we see the results of poor decision making every day — couples on the verge of divorce over financial miscues and others with no idea how they are going to pay for retirement much less fund college. So if the basic approach — analyze your options, make a choice and live with the consequences — is relatively straightforward … why don’t people make better decisions? Decisive, a new book by noted authors and professors Chip and Dan Heath, not only reveals common destructive shortcuts the brain makes during decision-making, but provides ideas on creating an effective process for making informed choices we can live with. Tip 1: Widen your focus The brothers call this pitfall the “spotlight” viewpoint. It isn’t unusual for a financial planner to meet with a client who has done everything right in terms of saving for the future but is counting every moment until retirement. As part of the comprehensive planning process, we can help them lay out more desirable options. They begin to understand it is all about tradeoffs: perhaps downsizing their home sooner rather than later; or working during retirement at something they love. The key is getting a broader perspective and for many people, a financial planner is an invaluable guide when navigating life’s biggest transitions. Tip 2: Avoid cooking the books There is a natural tendency to prefer information that supports our attitudes and beliefs. As fee-only advisers, we see this mental phenomenon all the time when reviewing clients’ prior investment brokerage statements. They don’t see management, fund or trading fees clearly presented on their statements so they assume they aren’t paying them — even though that makes no sense. So the best approach an investor can take to avoid this kind of confirmation bias is to play devil’s advocate. In our practice, we encourage questions — what am I paying, are fees reflected in my returns, and are these fees standard for the services I’m receiving?

Tip 3: Think with your brain, not your gut

Putting kids before retirement needs is a common money mistake we see as planners. Parents rightfully want to give their children every chance in life but fail to integrate these desires with a solid financial game plan. Conflicted emotions often lead to procrastination and at its worst — marital conflicts. In our experience, having a frank, open discussion with your children regarding how their college choices affect your personal financial plan does wonders to bond the family closer together and help your children understand how present financial decisions have long term affects.

Tip 4: Don’t try to predict the future

One of the biggest pitfalls of self-investing is overconfidence in predicting the future. Numerous academic studies have shown that active investment management’s “market timing” methodology doesn’t work. It is still, however, one of the most frequent conversations a passive investment manager has with his/her clients. “What do you think the market is going to do?” “I know you’ll get me out if it gets too bad.” Fortunately, a good adviser knows stock markets are volatile in the short-term. The adviser’s value-add is keeping the client focused on long-term, diversified, disciplined investing based on the client’s own specific circumstances. As financial planners, we have learned that people are often aware of their shortcomings around money. The issue usually boils down to — “but what can I do about it?” And this is where process really trumps analysis. The financial planner helps the client define his or her goals, analyzes the client’s financial circumstances, develops a realistic game plan with options and helps implement the plan in a meaningful way. When the inevitable road blocks appear, the client has a professional partner to provide unbiased advice, a broader perspective and moral support. After all — knowing where you are going is only the first step. It’s all about getting there.