Why we struggle to think long-term

Why we struggle to think long term

Investing is something human beings find far more difficult than it ought to be. The reason has little to do with the markets themselves and everything to do with the way our minds work. One clear example is our heavy reliance on intuition, a mental shortcut that serves us well in many areas of life but works against us when handling money.

In this video, Professor Arman Eshraghi of Cardiff Business School, an expert in behavioural finance, explains the two ways humans approach judgement and decision-making. There's thinking, the deliberate mode that engages when you're asked to calculate the square root of 293. And there's intuition, the instant, instinctive response you give when asked whether you like pepperoni pizza. Intuition is genuinely useful across much of life. But when it comes to financial decisions, it's the thinking mode you want to be in.

You'll learn about a second, deeper problem: investing demands a long-term perspective, while humans are naturally far more interested in the here and now. Most of us ignore the distant future and focus too heavily on the present, a tendency behavioural finance calls present bias. As a result, we fail to plan adequately for long-term events such as retirement, simply because they don't feel close enough to matter yet.

The key, Eshraghi argues, is to train yourself to focus on the long term, because once you do, investing turns out to be considerably less risky than most people assume. Solid academic research shows that investing in equity markets tends to be a relatively safe and profitable approach over long horizons. If you can avoid getting embroiled in the short-term ups and downs of the stock market, you can, on average, earn reasonably attractive returns at relatively low risk. The more you distance yourself from unhelpful emotions, the more consistently and robustly you can invest.

The takeaway: all of this sounds simple, but in practice it rarely is. Some people get the hang of it and then, for one reason or another, lose their way. Having a financial adviser you can turn to for an objective opinion is one of the best ways to stay focused on what genuinely matters.

Chapters / Key points

• Why investing is harder than it should be
• Why we rely so heavily on intuition
• The two modes of decision-making: thinking and intuition
• Why intuition works in life but fails in finance
• What present bias is and how it distorts our planning
• Why we neglect long-term events like retirement
• Why a long-term horizon makes investing far less risky
• What the research says about equity returns over time
• Why distancing yourself from emotion improves your investing
• Why an adviser helps you stay focused on the long term

Transcript

Why we struggle to think long term

Robin Powell: 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.

Arman Eshraghi: 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.

Robin Powell: 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.

Arman Eshraghi: 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, etcetera, we don't plan for them sufficiently, because we don't see them as sufficiently close.

Robin Powell: 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.

Arman Eshraghi: 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.

Robin Powell: 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.