Reducing the Risks from Your Brain

Thursday, July 24, 2014 |

“Knowledge alone isn’t enough. Even though we know it’s a bad idea to buy high and sell low, spend more than we earn, or invest in only one stock, we still repeat these mistakes… So ignoring what we’ve learned in the past makes it difficult to benefit from that knowledge. And pretending that there’s no consequence in the future for the decisions we make today creates a similar conflict.”

The above sums up what I found to be a quick, insightful article in the New York Times. It touches on the most overlooked issue in personal finance – the psychological barriers to making sound financial decisions. 

We take great pride in trying to educate our clients, often using the phrase “a great client is an educated one.” However, as the article indicates information alone may have limitations when rubber meets the road as the client may convince him or herself otherwise using the “this time is different” or “we can make up for it down the road” or anything really as a reason.

The article mentions “by recognizing the impact our [psychological issues] may have, we stand a greater chance of turning that knowledge into good behavior”, but does little mention ideas to help with the recognition. We understand that human nature won’t change and thus those issues will never go away. Thus, we have taken steps to minimize their impact and proactively prevent them:

• Build a financial roadmap so clients have a clear understanding of how a financial decision will affect their long-term goals and objectives and balance sheet/cash flow trends.

• On top of client education, we take time to answer all client questions thoroughly so they will understand our plan to alleviate their concern.

• Transparency in our process helps understand the how and why of our recommendations.

• Reducing risk as market movements indicate a higher probability or large loss in the future in order to keep them from selling at the bottom.

• Meeting clients in the middle. For example, putting a % of what they were going to invest in a private investment instead of the original amount

Of course, these methods are not perfect and we constantly evolve to find new and better ways to mitigate the psychological risks. Still, the above are good first steps to recognizing the deficiencies we have and taking steps to avoid the pitfalls the deficiencies can bring.