Editor’s Note: This story originally appeared on NewRetirement.
Some sources estimate that we make 35,000 decisions a day. This equates to approximately 2,000 choices per waking hour.
Fortunately, most of these decisions (what to eat for breakfast or what shoes to wear) are made quickly and instinctively. However, there are many life choices that deserve a much deeper look.
In particular, financial decision-making benefits from in-depth analysis, careful research and emotional control.
Here are 13 tips to help you improve your financial decision-making.
1. Maintain a holistic financial plan
You’re more likely to get where you want to go if you know where “there” is and have a plan to get there. Stay focused on your long-term goals and you’ll make better decisions.
Research has found that people who stick to a financial plan make better decisions and have better financial results. They save more, invest and use their debt appropriately, rebalance, budget and more.
2. Slow down, give yourself time to be rational
Financial decisions should not be made quickly. This is one of the key lessons in Nobel laureate Daniel Kahneman’s groundbreaking book, “Thinking, Fast and Slow” and its follow-up, “Noise: A Flaw in Human Judgment.”
You may feel like you need to buy or sell a stock today, but you don’t unless you know what you’re doing and have built the move as part of your financial strategy. global (which would mean that you have already slowed down the process).
There are very few decisions that aren’t improved by sleeping on them. A waiting period of 24 hours (or more) may be a good policy when faced with a financial decision.
3. Beware of your emotions
Stress. Loss. To fear. Greed. Shame. Urge.
Optimism. Trust. Enrichment.
These are some of the common emotions that can steer you towards the wrong financial decision. So-called good emotions can be just as damaging as negative ones.
Kahneman said: “People are very loss averse and very optimistic.” He points out how these emotions work against each other in a particularly damaging way. Because people are optimistic, they don’t realize how bad the odds are.
4. Trust Algorithms
In a presentation, Kahneman said, “Algorithms beat people about half the time. And they match individuals about half the time. There are very few examples of people outperforming algorithms in making predictive judgments.
The net net? When there is the possibility of using an algorithm to make a decision, you must use it.
The NewRetirement Planner is a great way to use an algorithm to help you make a good financial choice. It’s personalized, unbiased, and lets you run scenarios with the decisions you’re trying to make and compare different potential outcomes.
5. Make financial decisions within a system of choice
The only problem with running a scenario for a financial decision is that you have to realize that the scenarios you run are not done in isolation. There are a myriad of other factors, some related and some unrelated, that affect the results.
A decision can have a cascading impact. This can trigger a different set of options down the road and change the priority of factors that impact results.
Kahneman said, “Think of the decision as one member of a class of decisions you’re likely to have to make.
6. Think about the different possible outcomes
When you make a decision, you have an idea of what you think and want to happen. But, as the saying goes, “the best-laid plans of mice and men often go wrong.”
It’s helpful to consider at least a few things that could go wrong with your proposed decision and use that information to help you make the best possible choice.
7. Consider how regret influences decisions
Kahneman says “regret is probably the biggest enemy of good personal finance decision-making.”
Research suggests that the more potential for regret, the more likely you are to make the wrong decision.
regret theory postulates that people will anticipate regrets and make potentially bad decisions based on bad things that might happen, not necessarily what is likely to happen.
So, when making a decision, you need to understand that the potential for regret can cause you to make a suboptimal choice.
8. Make sure you ask the right questions
If you don’t ask the right questions, you have little hope of getting the right answers.
A common problem with financial planning is that many people first want to know: 1) whether they can retire early and 2) how much they need to retire.
These are valid questions, but without determining how long you will live and how much you need or want to spend during that time, you cannot get a valid answer to the questions you really want answers for.
The NewRetirement Planner allows you to vary spending over your lifetime and run scenarios with different longevity ages to help you get reliable answers about your future security. Want to know when you can retire? First, create a detailed future budget!
9. Get advice from trusted advisors, especially those who think differently from you
Getting feedback from people you trust can help broaden your perspective and limit bad decisions. Just hearing differing opinions can quiet the noise that might lead you astray.
Kahneman says the ideal counselor is “A person who loves you and doesn’t care about your feelings.”
However, it is also important to understand:
- What an advisor stands to gain from one conclusion or another
- What noise they may encounter when formulating their opinion.
- The relevance of the data used to make the decision — was it based on anecdotal or data?
Automating savings, investing, monthly payment, and bill paying are all great ideas. This takes the human element of noise out of the equation and boosts consistency.
11. Don’t over-index short-term benefits
Human beings have an inherent penchant for short-term benefits. However, your financial decisions are not only important for today, but also for your whole future.
It’s important to always consider the impact a decision will have on your life right now. Will you have less or more money this month to spend, for example?
However, it’s equally important to think about the impact of your financial decisions on your future. A dinner out means $100 less to save and invest, which alone won’t make or break your financial prospects. However, if you do it every week, you could lose a year of the life you want in retirement.
Here is seven tips for connecting with your future self to make better financial decisions today.
12. Put yourself in someone else’s shoes
A good way to overcome your own emotions is to visualize how someone else would approach the financial decision you are trying to make. Consider how other parties involved benefit or lose from your choices and what their interests are. Consider how a friend or colleague might approach the decision.
This is a particularly effective tactic if you are asked to buy a financial product. To understand how the seller might benefit from the decision, put yourself in their shoes. Strive to understand what they are getting from your choices. Their motivations might not match your interests.
13. Set up rules to guide decisions
Not everything can be analyzed with data. When you can’t use an algorithm to make a decision, it helps to have a set of rules to help you know what to do.
For example, let’s take your asset allocation. The way your money is invested should be based on some sort of logic, and the actions you take when your asset allocation is out of balance should be predetermined. So, if the stock market drops quickly and your funds lose value, you should already know what you are going to do if that happens.
It may be the role of a Investment Policy Statement (IPS). An IPS is supposed to define:
- Investment objectives
- Strategies to achieve these goals
- A framework for making smart changes to your plan
- Options for what to do if things don’t go as planned
Although it is possible to write an IPS on your own, this is usually done with a Certified Financial Planner (CFP). Developing an investment plan strategy is an efficient and cost-effective way to hire a paid financial advisor. They can help you determine the right asset allocation and suggest specific investments.
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