Personal Finance Involves More Than Just Numbers

To achieve the best fit, financial planning has to come out from behind the numbers. While the numbers provide a framework, they don’t tell the entire story. Why? Every client is unique. More to the point, the numbers don’t account for the most important element of any client’s story. Human behavior.

Human behavior is often beset by factors other than reason and logic. For example, fear or group think can influence investment decisions and lead clients to react emotionally to external factors. Similarly, unique personal histories can lead one client to be more motivated by living debt-free, while another is motivated by the prospect of higher returns. At Precedent Asset Management, we work hard to understand our client’s goals, individual personality traits, and emotional triggers to craft a plan that encourages a consistent, disciplined course of action.

Financial planning is a delicate balance between psychology and mathematics. The best plans do not rely solely on complex formulas, but combine the necessary calculations with the acknowledgment that human behavior will ultimately impact the success of any plan. The most detailed and succinct plan is absolutely useless if left without implementation. Sometimes it can be best to take a planning path that is inconsistent with or agnostic to the mathematical formulas. Developing a holistic client profile allows us to better guide our clients in a direction that will produce the desired long-term results.

In trying to craft a holistic plan for our clients at Precedent Asset Management, our advisors work to identify the following common investor tendencies.

  1. Overconfidence. This leads to an assumption that the future will closely match past performance. Investors can be lulled into a false sense of preparation and disregard information that conflicts with their optimistic expectations.
  2. Familiarity bias. Investors develop a higher comfort level and thus assume lower risk exists for investments with which they are already familiar. This can produce portfolios that improperly diversified.[1]
  3. Worry. This tendency is ordinary, expected, and widespread. The degree of worry associated with a particular investment increases the perceived risk, regardless of the real risk.

Adequately assessing the level of overconfidence, familiarly bias, worry and other behavioral tendencies allows us to customize plans and treat our clients as individuals with unique needs, goals, and paths to achieve desired results. Rather than pushing a cookie-cutter approach that relies heavily on calculating unrelated formulas, accounting for human behavior helps our advisors reduce the influence of tendencies that might interfere with our clients achieving their long-term goals.

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[1]https://www.onefpa.org/journal/Pages/MAR15-Understanding-Behavioral-Aspects-of-Financial-Planning-and-Investing.aspx