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RP: Investing is something that human beings find far more difficult than we should.
Why? Well, it’s simply down to the way we are.
One example is our tendency to rely quite heavily on intuition.
Professor Arman Eshraghi from Cardiff Business School is an expert in behavioural finance.
AE: We approach judgement and decision making in two ways — we humans. There is what we call “thinking”, which is… when I ask you “what is the square root of 293?” That’s when your thinking brain kicks in. But then there’s intuition and instinct… so, if I ask you “do you like pepperoni pizza?”, then you would give an instant response to that without thinking too much. And that’s your intuitive response.
So this intuition is actually very helpful in various areas of life. But, when it comes to financial decision making, it’s not helpful. The mode you want to be in is the thinking mode.
RP: Another problem is that investing requires a long-term perspective.
People are naturally far more interested in the here and now and in the immediate future.
AE: Most humans actually ignore the distant future and focus too much on the present. That’s known as the “present bias” in behavioural finance.
And therefore, when it comes to events that happen in the long-term — whether it’s going into retirement, etc. — we don’t plan for them sufficiently, because we don’t see them as sufficiently close.
RP: The key, says Professor Eshraghi, is to train yourself to focus on the long-term.
That way, investing is actually far less risky than many of us assume.
AE: Very solid academic research shows that investing in, for example, the equity markets tends to be a very relatively safe and profitable approach or alternative to other forms of investing in the long-term. So, if you have a sufficiently long horizon, and if you don’t get embroiled in the short-term ups and downs of stock markets, then actually — on average — you can make reasonably attractive financial returns at relatively low risk.
And therefore the more you distance yourself from these sorts of unhelpful emotions, the better you can invest consistently and robustly for the long-term.
RP: All this sounds simple. But, in practice, it often isn’t.
Some people get the hang of it, but then, for whatever reason, lose their way.
Having a financial adviser you can turn to for an objective opinion is a good way to stay focused on what’s important.
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