Do you intend to make a “financial resolution” this new year?
You may want to consider something specific, such as deciding to pay off a credit card or track down a lost pension. Perhaps your goal is broader than that: to be “better” with money, with the goal of devoting yourself more at the end of the month (or at the end of your working life).
To achieve this, some people will consult a professional financial planner. You are likely to be asked what your financial goals are. Once they know what you want to achieve, they can help you organize your finances accordingly. But does anyone really have financial goals? I think what we all have are life goals, which may or may not have financial implications.
So instead of thinking about a financial resolution, try to articulate and write down your life goals. Doing so can have an impact on achieving them, helping you stay focused in the face of distractions, setbacks, or challenges.
You can write, “I want to be mortgage-free at age 45” or “I want to retire at age 60.” But instead of setting such a binary result of achieving a goal for a certain age or date, think of it as a financial milestone.
Milestones are a bit like waypoints on a long trip, as they allow you to check that you’re on track, without worrying too much about how long you have to travel to get to your destination. If you measure the progress you’ve made in achieving these goals over the past year, five years, or decades, you can be a little easier for yourself and this will help you protect your confidence and reduce feelings of guilt or frustration.
According to the work I have done with clients over the years, the general financial goal of most people is to get to a place where money doesn’t worry them or stop them from living the life they want.
In the early stages of the trip, reducing money-related worries by eradicating unsecured and costly debt, controlling day-to-day expenses, and building a proper emergency fund can do wonders to improve your overall sense of well-being, whatever your financial circumstances.
William Bernstein, a financial theorist and neurologist, points out how important the name of the game is not to get rich, it is not to die poor.
Another aspect of mastering your money is to develop effective habits and behaviors that serve you on a daily basis and that are met over time to improve your financial position. A good analogy is the medical one I recently had for income protection insurance.
After a thorough review, the doctor asked me about my lifestyle and diet. I was impressed by my overall level of fitness, and I got the impression that this was the exception, not the norm for a 50-year-old guy. I am glad to say that I approved the doctor and they offered me coverage at normal prices.
Clearly, genetics play an important role in my health, but my current good physical level is mainly due to the effective habits and behaviors I have developed over time. Whether it’s what I eat and drink, the quality of my sleep, my exercise routine, or my environment, my daily decisions over the past 30 years have had a cumulative impact.
The same principle applies to money. Many rich, higher-income people do stupid things with their money. In the heat of the moment, people can do things that destroy wealth, but bad monetary habits can also develop over time.
Do you recognize any of these five behavioral biases that the professional advisory firm Cerulli Associates found significantly affected investment decisions and the wealth of its clients?
In the first place is the recent bias (easily influenced by recent events or experiences). This could be paraphrased as “Help, the stock market has crashed, let’s sell everything at the bottom.”
Second, there’s the loss aversion bias, which is also known as playing it too safe. If you are someone who keeps most of your assets in cash, it is you. Psychologically, you think you are avoiding risk. But playing it too safe means a lost return on investment.
Third, the confirmation bias. For investors, this could involve looking for information that reinforces your perception that it is worth buying a company’s shares instead of challenging them.
Cerulli found that a similar number of people were guilty of familiarity or home bias; you preferred to invest only in family or domestic companies, which means your portfolio contains more concentrated risks than a diversified one.
Finally, anchor bias, which is a tendency to rely too much on initial information when making investment decisions. This could be the proverbial pub man who suggests you do a little obscure. While the evidence suggests that this would be a terrible idea, your mind remains fixated on disagreement.
One of the report’s authors notes that “recognizing behavioral biases is an important first step in controlling emotions and avoiding erroneous steps that can have a negative impact on long-term financial goals.”
If you recognize any of these five trends, don’t panic: Cerulli’s research also named the three most effective behavioral bias mitigation techniques to protect them.
First, have a long-term vision. I can’t stress how important this simple rule can be: Short-term market changes will have little impact on your portfolio over several decades.
Second, implement a systematic investment process (an appropriate system for evaluating your investments, which can help you avoid the appeal of elusive participation tips), and finally adopt a goal-based planning approach.
Developing effective money habits, having a lifestyle that can be afforded, and thinking carefully about your family’s priorities will help you identify and achieve these goals or milestones – the key to making money serve you throughout your life.
Whatever stage you are in, a new year offers you the opportunity to rethink your income, expenses, savings, investments, and behaviors and habits to ensure that they are aligned with what really matters.
It’s also a good time to make sure your financial life is well organized, so you feel in control and you won’t leave any mess to your loved ones when your time is up.
If you’re the type of person who loves the to-do list, you can download my simple one-page financial plan template here. Mark what you’ve achieved, jot down your goals, and track your progress throughout 2021, and keep in mind that there’s also room to budget for “fun and life experiences” next year: another way vital investment that should not be neglected.
Jason Butler is a financial welfare expert and presenter of the “Real Money Stories” podcast. Twitter: @jbthewealthman