Deterred by the large number of investment options available, many would-be investors fail to make the most important decision: the decision to start. Becoming aware of how you approach financial decision making may help you overcome this common stumbling block, writes Didintle Mokonoto.
We all want to make good investment decisions but, despite the best intentions, the thought of making the wrong decisions with our hard-earned money often triggers a state of analysis paralysis. Our emotions also get in the way and can lead to expensive mistakesor overwhelm us to the point of complete inaction.
Consider this scenario: Dimakatso is a single mother. Her 8-year-old son Lethabo dreams of becoming an accountant like his favourite uncle. After chatting to her colleagues and friends, Dimakatso fears not being able to provide for Lethabo’s tertiary education.
She is faced with two options:
- Dimakatso could choose to bury her head in the sand. After all, she doesn’t know where to begin and the thought of trying to save up over R400 000 (excluding additional expenses and taking education inflation into account), while meeting her current expenses, is overwhelming. This would mean that when Lethabo finishes high school, Dimakatso would need to consider taking out a loan to pay for his studies or encourage him to explore cheaper alternatives.
- Dimakatso could do some research, contact an independent financial adviser and find out how much she would need to save each month to fund her son’s tertiary education. She could then commit to a consistent and affordable investment strategy over the next ten years that meets her needs.
Overcoming inertia and emotions, like fear, is an important first step in investment decision making.
Decision making is in our DNA
It may surprise you to learn that, despite our difficulty in making big decisions, we are generally efficient decision makers. Some estimates suggest that the average adult makes about 35 000 decisions each day. Of course, many of these are simple decisions, with researchers at Cornell University saying that over 200 of our daily decisions are food-related. Some decisions are as simple as deciding which teaspoon to take out of an open drawer and others are more complex, like choosing an investment manager or selecting the right unit trust.
According to researchers and psychologists, there are five general decision-making styles. We each tend towards a dominant decision-making style, which is determined by the habits we fall into over time.
- Rational style – we spend a considerable amount of time gathering information and evaluating the options to make informed decisions in a systematic way.
- Dependent style – we tend to take the views of others into account or outsource our decision in its entirety to someone else.
- Intuitive style – we rely on our instincts to make decisions, drawing on our gut feelings rather than the hard facts.
- Spontaneous style – we make snap decisions as quickly as possible, often selecting the first option we’re presented with.
- Avoidant style – we ignore the fact that a decision needs to be made, and often don’t make a final decision at all. Depending on the nature of the decision, some of these approaches will be better-suited than others. Given the serious nature of investing, it is better to approach your decisions with a rational decision-making style, but at times it may be useful to draw on the other decision-making styles. For example, when choosing an investment product, it may be best to adopt a dependent style and delegate a number of the decisions to an independent financial adviser who has the knowledge and expertise required to choose the product that is most suitable for you.
Investment outcomes generally aren’t influenced by one decision, but rather the compounding of a series of decisions. Let’s revisit our earlier scenario. The return on Dimakatso’s investment would be influenced by the decisions she makes along the way, including:
- The asset manager she chooses to manage her investment – and their performance over the period.
- The product/underlying investment options she selects – and their appropriateness for her needs and objectives.
- When she starts investing – and the length of time she remains invested.
- The amount of money she invests each month.
- Whether she decides to consult a financial adviser, or not, and their ability to help her achieve her goals.
Dimakatso will probably apply different decision-making styles to each of these smaller decisions. She may not be able to control external factors like what the financial markets return, but the decisions she can control will compound and ultimately influence whether she is able to pay for the cost of Lethabo’s tertiary education.
Making better investment decisions
Researchers have found that following logical decision-making processes is more likely to lead to successful decisions. By approaching our financial decisions with a process-driven technique, we can limit the influence of our emotions and improve our outcomes. Consider integrating some of the elements below in your financial decision-making process.
- Prioritise your decisions: Decide which financial decisions are most important and spend most of your time and effort researching and reflecting on them.
- Seek advice: Source expert opinions, consult an independent financial adviser and gather as much information as you can.
- Keep your goals in mind: Whether long-term or short-term orientated, your investment decisions must align with your goals.
- Crunch the numbers: Numbers are intimidating for many of us, but they can simplify the decision-making process. An independent financial adviser may be able to provide you with some projections to help guide your decisions.
- Reduce the number of decisions: Automation is a great way to reduce the number of decisions you need to make. Debit orders are a good example of this: They eliminate the need for regular decisions around contributing to your investments. Furthermore, you could add an annual escalation instruction upfront so that you don’t need to make decisions about increasing your contributions in the future.
- Learn from your mistakes: Even the most successful investors make mistakes. Bad investment decisions usually offer important investment lessons and should not deter you from investing in the future.
The value of expert advice
Many investors underestimate the benefits of good financial advice. An independent financial adviser will look at your unique set of circumstances holistically and develop an appropriate investment strategy to help you achieve your saving and investment goals. This increases your likelihood of success, and can help narrow down your options, easing the decision-making process.
Time is key when it comes to investing, so you want to get started as soon as possible. By committing to a simple, solid and sustainable strategy you can limit the number of decisions you are required to make and achieve your investment goals.
This article was published on the Allan Gray Website on 17 July 2019.