RP: Experts in human behaviour have observed a number of biases that people are prone to. But, specifically regarding investing, which is the most harmful bias of all? Sarah Newcomb is a senior behavioural scientist at Morningstar. For her, there’s a runaway winner — present bias.
SN: Present bias has us thinking about the here and now. We care much more naturally about what is definitely happening right here right now to me, than something that might happen in the future to our future selves, somewhere else in the world where ever we happen to be at that moment.
RP: Most people, in fact, exhibit present bias to some extent or other. And in many respects, it serves us well. But investing is a good example of how our focus on the here and now can work against us.
SN: In the world where we live the present moment is important but we outlive our physical ability to work in many cases. So in a world where we need to have an income when we cannot be actively producing that income, we have to prepare to have other sources of income other than labour when we can not labour anymore. We do not think about that future because we are so biased toward the present. By the time people start to think about their old age it is too late, they can not catch up to what they will need and so many people are under-prepared.
RP: As with most behavioural biases, the solution seems simple. To combat present bias, we need to pay more attention to the future and to take more care of our future selves. But these biases are part of us — they’re built into our personalities — and changing our ways isn’t easy.
SN: This is what got me into the field of behavioural economics. I am so presently biased. I am an impulsive person. I am distracted by shiny objects. I have found that sound financial decisions are rooted in being able to think clearly about the future, to properly estimate your needs for your future self and weigh them well against your present needs. This is something that is inherently difficult for human beings, some of us more than others.
RP: So if even the experts struggle with these biases, it’s no surprise that most of us do. Again, there are no easy answers, but having a plan for your long-term financial future is hugely important. So too is having an adviser who can help you stick to the plan when those inevitable distractions come along.
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