Are your emotions setting you up for failure in retirement? A little knowledge and understanding of the impact of your emotions can help you avoid major pitfalls in retirement.
If the act of investing and saving was based solely on mathematics. Decisions made on a robust framework. Retiring with a healthy nest egg would be a foregone conclusion for most retirees.
In the real world, we are human beings with feelings, emotions, wants and conflicting interests.
So much so, there is a field of study called behaviour finance which studies how psychological behaviours and biases impact investor decisions.
We all succumb to one or many over our lifetimes. While these behavioural tendencies can cost you a lot of money if not managed. We’re discussing two BIG ones so you can identify them and change your behaviour so it doesn’t cost you your retirement lifestyle.
Behvioural biases are so great there are many studies showing the impact of managing such biases as an investor.
More often than not this is where an adviser can add the most value. Vanguard has studied this area of finance for some time. In their annual Value of Advice “Adviser Alpha”, they state the value of an adviser can add 3% to the value of their investments.
Of that 3%, 1.5% relates to behavioural coaching…keeping people from making simple yet costly financial mistakes.
Russell Investments, who also conducts a yearly study in this field, stated Behavioural coaching added approx 2% of investable assets in value each year.
There have been many, many books written on the topic. My favourite, “The Psychology of Money“, by Morgan Housel.
Unfortunately, unlike computers which receive regular updates…the human brain has not had one for centuries. The main reason many investors continue to make the same financial mistakes time and time again…
Overconfidence is lurking all the time…
One of the most common behavioural biases we see on a daily basis. It lulls you into a false sense of security when things are going well. But causes mayhem when things go the other way.
Most commonly, overconfidence takes hold when investment markets have performed really well. It’s like a dopamine hit.
It’s addictive…you’re on top of the world…it’s an emotional high.
You start looking at the world through rose coloured glasses…
One recent example of this was a prospect I spoke too. They were retired and had done really well in their portfolio. Double digit returns for a number of years…things were looking great.
Once we applied a framework to their current position. We found there was a potentially devastating risk they were taking.
“Overconfidence” bias had engulfed them…addicted to the dopamine hit.
We know investment markets don’t go up in one straight line. It rises and falls over time with an upward trend over longer periods.
When markets retreat…and they will…we just don’t know when.
These guys were putting at risk $500k of their retirement portfolio. In other words, if they did not take precautions their $1m portfolio could potentially halve in value in the next market crash.
This would be a devastating experience if they continue with unrealistic optimism. With huge losses only a market downturn away.
In addition to being overconfident. When markets are going well, an investor can be overconfident in their own abilities.
Self directed investors think they can outperform investment markets…think they know everything about investing.
Sadly most are amateurs…one step away from a devastating experience…
You need to take a step back…be aware of the risks and find ways to mitigate those risks.
Just like you use a seatbelt in your car to cut down the risk of dying in a car crash…take precautions when road conditions worsen.
Exercising prudence and caution in your plan can protect you from devastating losses.
As you approach retirement moving from accumulation to decumulation…it’s a different game with a different set of rules…
Following the herd…don’t do it…
Another emotional bias is herd behaviour. Ignoring your inner thoughts of caution or advice of professionals and instead choosing to “follow the crowd” and its strategies. Without any thought of what is right for your unique situation.
Two most common ways this shows up…
#1 The buzz of now…
Watching investment markets going up…thinking I’m going to miss out. You buy in at the height…only to watch it come crashing down…only to sell at the bottom and never invest again.
The same can be said for new age investments like crypto currency. The fear of missing out comes into play. Everyone else is doing it…it must be good…wrong.
#2 The best of super…
Ohh…this is a big one. Super funds with big pockets advertising their marvelous performance.
Praying on people’s fear of missing out…without telling the whole story. Understanding the individuals real needs.
Decisions made on what they see and hear and not based on asset allocation and the right structure to generate a consistent income in retirement.
Rarely does any real thought go into the decision.
The wrong move can be devastating years into retirement…
Mastering your emotional biases…
There are many, many more biases which impact your financial decisions on a daily basis. This is only the tip of the iceberg.
It’s called the “Behaviour Gap”, and everyone succumbs to this at some point…you just don’t want it to happen leading into retirement.
Succumbing to “overconfidence” or “herd mentality” can be devastating to your retirement dreams. The only problem is you won’t know until it’s too late.
The best approach is to ignore what is going on around you…ignore what everyone else is doing.
Your retirement plan needs to be based on your individual needs.
The lifestyle you want to live…the amount of money to see you out…the investment return you need to achieve and risk strategies to protect your retirement lifestyle.
It’s different for each person…
The best retirement plans are boring…not that exciting because they address the emotional biases we as humans face every single day.
Knowing that we all are subject to biases is a powerful argument for having a written roadmap. A roadmap which sets out why you are investing and your personal goals. It’s your retirement play book. Which in times of financial stress can be used to either adjust or simply stay the course. Keeping you safe from emotional biases which could sink your retirement dreams…
If you’re heading towards retirement, it’s time to get your game plan in order.
If you’re open to it, I’d be happy to do a complimentary appointment with you to talk through some of the challenges and questions around your situation. To help give you some clarity and maybe a roadmap on getting clear on your retirement gaps and what you can do to fix them.
Glenn Doherty – CFP – Retirement Planning Specialist | Retirement Planning Made Simple for Over 55’s powered by Life-Centred Financial Planning