Establising clear values and objectives can help prevent mistakes

The fewer choices you face, the fewer opportunities there are for errors. Therefore, one way to reduce the effect of bias on your financial well-being is to make fewer decisions.

 

This doesn’t mean neglecting your investments or other financial decisions. Rather, it means making decisions strategically to align with your long-term goals. While this may sound straightforward, investors should beware of how inherent biases and heuristics — potentially harmful decision-making shortcuts — can get in the way.

 

The G.I. Joe fallacy refers to the public service announcements that ran alongside the popular 1980s cartoon series, with the tagline “Knowing is half the battle.” Every parent knows that isn’t true. Telling a child not to run into the street isn’t enough to stop them. Sometimes we do things we shouldn’t, even when we know better.

 

In financial terms, most people know that buying high and selling low is not a sound investment strategy. But that doesn’t mean it’s easy to resist the fear of missing out on a surging investment or the urge to cash out in a bear market.

Most people also know it’s a good idea to have a financial plan, but very few people spend time developing one. However, a plan with a clear destination means fewer decisions are required along the way, leading to fewer mistakes.

 

Therefore, it’s important for investors to determine where they want to go. This sounds straightforward but it takes time and energy to execute.

 

Start by understanding your core values or, in the case of financial decisions, your personal economic values. Beyond the obvious list of what you want to have or achieve over your lifetime and understanding your financial skills or limitations, consider other fundamental questions, such as:

• What keeps you up at night?
• What are your beliefs about borrowing, spending and saving?
• What should you stop spending on?
• Which professionals can add the most value to your plan?
• Which financial decisions are you most happy with?

Your decisions propel you in the desired direction when your personal economic values define them. That’s important because investors often react hastily to market fluctuations and news events, undermining long-term objectives. It’s natural to want to feel a sense of control, and making changes when experiencing discomfort provides temporary emotional relief. But more often than not, those changes derail a well-constructed plan.

 

When markets drop, stopping your monthly contributions until the volatility subsides will result in reduced retirement savings. Holding cash too long or selling at the wrong time carries significant, long-lasting effects.

One way to manage emotional reactions is to monitor investments with the long-term plan in mind — not the day’s market moves. Even a risk-averse investor can tolerate a well-crafted equity investment strategy when they refrain from incessantly monitoring their investments’ price fluctuations. In any five-year rolling period between 1980 and 2022, an investor in the MSCI World Index would have had a negative return on only five occasions. And if left for one additional year, the return was always positive. That’s why limiting your interactions with your portfolio can help prevent poor decisions and provide better long-term returns.

 

Understanding your values and objectives enables you to avoid emotional decisions. Your financial success is not determined by the volume of decisions you make but by the purpose behind each one.