At the April ACSIS/Personal Finance Financial Planning Club presentations, Prof Zak Nel and Gerda van der Linde of the SA Institute of Behavioural Finance explored the factors influencing financial behaviour. The core of behavioural finance is how irrational or illogical factors affect your financial decision making. You need to be aware of these irrational or emotional mistakes and be able to identify them so you can take remedial action, Zak Nel says.
Gerda van der Linde said some participants in the financial services field believe complying with the Financial Advisory and Intermediary Services (FAIS) Act, the only requirements are to do a risk analysis and make the correct investment choice. It is not this simple, by far. To avoid misunderstanding your investment needs and decisions, your financial advisor needs to consider your psychology as well.
Van der Linde also said your personality and the way you think influence your cognitive and emotional state. The social environment has also a role to play. Behavioural finance is not about how you should act but rather how you do act.
Your decisions are neither completely intuitive nor precisely logic and reasonable. Mostly you decide on taking action without second thought. You need experience and knowledge as well as time to make a good decision.
Van der Linde advises you to train yourself relying less on your emotions when making financial decisions. "However, this is not easy as your emotions serve to protect your self-esteem and emotional wellbeing." Social influences such as peer-group pressure can lead you to follow advice that is not in your best interest.
According to Nel, there are 16 different money personalities, based on the eight core characteristics of the Myers-Briggs personality questionnaire:
• The extrovert (E) relaxes in the company of others.
• The introvert (I) has fewer but deeper friendships.
• Sensing (S) people are also known as "here and now" people - they use their ears, touch and
vision to gather information and examine the details.
• Intuitive (N) people have a sixth sense and rely more on hunches, speculation and inspiration to
reach a decision.
• Thinking (T) people think through all the consequences.
• Feelers (F) make decisions based on how they feel at the time.
• Judging (J) types are goal orientated with specific plans in mind.
• Perceiving (P) types simply go with the flow.
Although all personality types have the potential to make good decisions, different types tend to make different kinds of financial decisions. Your personality type will also affect your relationship with your financial adviser.
Persons with ISTJ characteristics would be extremely careful and take time to consider potential investments. Once the decision is reached, it is usually a good one and they stick to it. A person with ESTJ characteristics would generally be a high achiever in the work environment. These are people with the most money to invest, particularly later in their careers, and they prefer to manage their own portfolio giving them a feeling of control. People with ENFP characteristics sometimes show overconfidence and overestimate themselves. They can also be quite impulsive in their decision-making.
Consumers are faced with a wealth of legislative changes, and an overload of available information. These changes include the FAIS Act, the National Credit Act, the Financial Sector Charter and the Pension Funds Act. Financial advisers are under pressure to keep up to date, while the abundance of information leave investors with uncertainty and some consumers completely confused. This can easily lead to irrational decisions causing financial loss.
There are certain systematic mistakes when we make decisions about money. You can protect yourself identifying these emotional triggers and stay away:
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Take the information out of the context it is presented in. The presentation may create illusions. A salesperson will seldom tell what the product is not. The product is put in a narrow frame telling us only its benefits. Our decision could change if the frame changes and we gain more information.
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Realise the power of marketing. When your financial advisor advises you, ensure he or she knows what your frame of reference is. This determines how we approach problems and investment products. If the financial adviser understands our needs, it reduces the possibility for misunderstanding or our money being placed in an unsuitable investment.
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Realise you may become very emotional about losing. Holding on to a losing investment, we avoid regret but also do not assume responsibility for our mistake.
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Be aware of your mental accounting habits. We are treating hard-earned money conservatively and "easy" money or windfalls with less caution.