Mind the (Behaviour) Gap

“It’s not that we’re dumb. We’re wired to avoid pain and pursue pleasure and security. It feels right to sell when everyone around us is scared and buy when everyone feels great. It may feel right-but it’s not rational.” From The Behavior Gap by Carl Richards

In difficult times, we tend to look for someone or something to blame if we lose money on our investments. Right now it’s the emerging market sell-off, the Trade War, the sluggish SA economy, the threat of land expropriation. There will always be something. The real trouble lies in the decisions that we make, however. Too often, panic sets in, and we let emotion get in the way of smart financial decisions.

Carl Richards, a US-based financial planner and author of the The Behavior Gap named this phenomenon the “Behaviour Gap” – the distance between what we should do and what we actually do. Understanding our emotions is key to avoid making the same mistakes again and again.

What so many don’t realise is that bad decisions about money aren’t failures. They’re just what happens when investors in an emotional state make decisions about the future with limited information.

Many believe that to make good financial decisions, you need to have a plan for every situation. All of your assumptions about the future need to be refined to perfection so that you will never be caught off-guard. You need to know and understand everything about the financial markets, and you need to budget your spending to the last Rand. This kind of thinking is based on fear of making a bad decision.

The trouble is, the real world is complicated. We don’t know what’s going to happen, so what then is the solution?

The answers are simple, but not easy. You need to focus on the things you can control, which can be incredibly difficult because no-one likes uncertainty, which in SA, is a fact of life. A big factor in addressing the fear factor is letting go of the ideal that you’ll make perfect decisions every time. There’s also the reality that you can’t protect yourself from everything. You’ll need to give serious thought to understanding (and being honest about) what you really want. Too often this is the last question that gets answered.

The fact is, once you have prioritised what you really want in life, you can begin to figure out how to get there. That’s because a great plan has nothing to do with what the markets are doing, what the property guru is pitching, or the next “hot” share pick you heard about at last night’s braai. Rather, it has everything to do with what is important to you. Having control over your time frames and how much you are willing to save will have a far greater impact on whether or not you achieve your goals.

Generally, most of us live with a distinct sense of unease. We have a vague idea about our kid’s education or our retirement, maybe taking an overseas holiday, or being debt-free at some point. But it doesn’t help to only have a vague idea when it comes to planning. When do you want to retire? What kind of lifestyle do you want in retirement? Do you plan to earn some form of other income after you retire?

We’re always being told that only 6% of South Africans can afford to retire, so where does that leave us? And how relevant is this question to our own situation?

As financial planners, we’re often asked: how much capital do I need to have when I retire? Naturally, the answers will be markedly different if you are retiring to a smallholding in Malmesbury or emigrating to the English countryside to be near your grandchildren.

Now more than ever, performance cannot be seen as a goal. Unfortunately in the current lower return environment, investors are far more likely to make poor emotional decisions when an investment is not performing well. But whether your investment performs better than your friend’s will have no impact on your ability to pay for your children’s school fees or your annual trips overseas. Obviously, the rate of return you earn on your investment is critical, but only insofar as it relates to you and your family’s goals. In other words, performance is a means to an end, not an end in itself. Hence the well-published research that highlights the fatal error of chasing the next best thing, be it a share, investment category or fund. These are decisions based on emotion.

Rather take the time to clearly define your goals and work with your adviser to develop a plan around these. This may necessitate a hard look at your own behaviour, particularly your spending.
And instead of just saving for one specific goal, such as an overseas holiday, your plan should prioritise where to allocate your spending and assets as they accumulate over time. Engaging with your financial planner will provide a buffer between your emotions and the financial decisions you commit to. Most importantly, it can help you to avoid the most common mistakes caused by the behaviour gap.

The ability to adapt your life plan over time also becomes more important than doing exactly the right thing in the first place. Your planner will help you to identify the blind spots that may prevent you from realising what goals are actually achievable.

In his book, Richards writes: “We’ve all made mistakes, but now it’s time to review those mistakes, identify your personal behaviour gaps, and make a plan to avoid them in the future. The goal isn’t to make the ‘perfect’ decision about money every time, but to do the best we can and move forward. Most of the time, that’s enough.”