Who hasn't made a poor decision in life? Perhaps you ate ice cream instead of dieting or binged on Netflix when you should have been doing your taxes (personally guilty).
Regarding your finances, maybe you made an impulse purchase or blamed others for bad choices. Don't be discouraged. You are human. It happens despite our best intentions, knowledge level or experience. Understanding why and how to avoid these behaviours can be explained through behavioral finance — the study of how people make decisions in relation to money.
By realizing we have blind spots, we may either take action ourselves or engage the help of others to keep us in check. Either way, the goal is the same — to make better financial decisions.
At TD Wealth, we use a behavioural finance discovery tool that helps investors identify, learn more about themselves and assist them to avoid their unique blind spots.
Here are some common financial blind spots:
1. Sensitivity to noise: We live in the technology age where information is over-abundant. Given the COVID-19 global pandemic, the noise level has been extreme and can be flat out disheartening. The problem with information is filtering out noise. There always is "breaking news" or a pundit telling everyone to get out as the next crash is coming. They are not accountable for when they get it wrong, which often is the case. Your wealth can suffer dramatically if you make a knee-jerk reaction. Remembering your investment goals and objectives, not the most recent headline, should guide you.
2. Resistance to taking losses or profits: Investors often put a lot of time, money and effort into stock picks. The hardest thing to do is sell. With bad investments, it is often because we hate to admit failure. With good ones, we expect the value will continue to rise and fear selling would be getting out too early. How many got it wrong with Nortel? Many believed their stock would continue to skyrocket when the unthinkable happened and it went to zero.
3. Framing: Consider you have a million dollars in a portfolio. Due to market events, you are down five per cent. Often, framing in terms of dollars elicits a stronger emotional reaction. Hearing you are down $50,000 could lead an investor to sell in panic. By looking at similar problems in different ways, it can help bring rationality to our decisions.
4. Short-term focus: Humans tend to focus on immediate needs (food, water, shelter, etc.). Saving for retirement 10 years away? Not so easy to prioritize when work, family and paying down debts demand the majority of our time. Human nature discounts a reward that arrives later. However, saving for the future is necessary in order to enjoy a well-funded retirement. Falling to the trap of "Once I pay for this, then I will save for retirement" tends to be a never-ending circle.
5. Over-confidence bias: Your friend picked a “sure thing” for his portfolio, which doubled in value. He is proud of himself and has told you and everyone else. That same friend then picked the “next sure thing,” but the price dropped in half. Now he's blaming the markets, the company, his advisor and even bad luck. The problem with attaching success to yourself and failure to an outside influence is that you may mistakenly grant yourself wisdom and experience you may not actually have and become overconfident in your skills.
Even the pros get it wrong from time to time. Warren Buffet, arguably one of the best investors of our time, has admitted his mistakes, learned from them and moved forward. He shows humility and a regimented process for investing.
To overcome your financial blind spots, you may wish to consult a professional who will work with you to design a plan that fits your unique lifestyle, goals and circumstances and help keep you on track.
Until next time, Invest Well. Live Well.
This document was prepared by Eric Davis, vice-president, portfolio manager and investment advisor, and Keith Davis, investment advisor, for informational purposes only and is subject to change. The contents of this document are not endorsed by TD Wealth Private Investment Advice, a division of TD Waterhouse Canada Inc.-Member of the Canadian Investor Protection Fund. All insurance products and services are offered by life licensed advisors of TD Waterhouse Insurance Services Inc., a member of TD Bank Group. For more information, call 250-314-5124 or email Keith.firstname.lastname@example.org.