The 3 Enemies Of Financial Planning
When you build a portfolio of assets with the intent of achieving your financial goals, you’ll invariably get some investment decisions wrong
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It looks like India Inc is finally waking up to the need for robust, comprehensive Financial Planning. Each day, we see a growing number of middle-income Indians who are realising the importance of defining their financial goals and tracking their key financial ratios. While it rings true that ‘well begun is half done’, it’s critical to be watchful of these three ‘enemies’ that will do their best to thwart your unhindered canter towards financial freedom. No, markets are not one of them! In fact, these enemies lie within you, as firmly ingrained behavioural biases.
Enemy No.1: The Sunk Cost Bias
An all too common behavioural pitfall, the sunk-cost bias is the term for the tendency to cling steadfastly to losing investments, despite an innate knowledge of their present inefficacy and often, an understanding that they have a limited scope of creating value for you in the future as well. When you build a portfolio of assets with the intent of achieving your financial goals, you’ll invariably get some investment decisions wrong. The sunk-cost bias will prevent you from getting rid of them.
How it manifests: as a scattered portfolio that’s all over the place, with no clear structure and thought behind its formulation
It’s impact on your Financial Plan: sub-par portfolio returns in the long-term
Enemy No.2: The Conservatism Bias
“Believe in yourself”, goes the old inspirational adage. However, when it comes to investing and financial planning, the old axiom needs to be adjusted as “Believe in yourself but keep your beliefs fluid”! The conservatism bias is what prevents individuals from changing their beliefs about a particular stock, asset class, or investment instrument; even in the face of overwhelming evidence that warrants a change in viewpoint.
How it manifests: as the stubborn refusal to rebalance your portfolio in a disciplined way, sometimes against the grain of the market momentum
It’s impact on your Financial Plan: returns that are volatile, resulting in poor investment decision making
Enemy No.3: The Action Bias
““Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas”, said none other than the Nobel Prize-winning American economist, Paul Samuelson. It’s a fact that passivity is a strength, when it comes to all things Financial Planning related. However, the Action Bias will prevent you from being passive – occasionally stirring up in you the mistaken belief that doing something is always better than doing nothing. The Action Bias is more likely to come to the fore during flat or bearish markets, although its known to manifest itself as excessive churn during bull markets too.
How it manifests: as impatience, plain and simple
It’s impact on your Financial Plan: high transaction costs and taxation, not holding on to good investments for long enough to create any serious long-term impact.