Financial self-awareness: when it comes to saving money, why knowing yourself is more important than knowing the stock market

One of the few bits of worthwhile advice from Rich Dad Poor Dad is that you should never someone that you are undecided as to where to put your money, and for how long. Firstly, financial advisers are motivated by their own self-interest to exploit your uncertainty, and put your money where they’ll reap the best commission - even if your own fund decreases in value. Secondly though, if you haven’t figured out what kind of investor you are, you’ll never be able to cultivate faith in your investment strategy.
After figuring out why you want money and what you want it for, it’s important to understand - and to be able to articulate - your own attitude regarding investing.
This includes your care factor, and your risk profile – which in turn informs your investment strategy.
On deciding what type of investment strategy you want:


"You only have two real choices: The first is to make a serious commitment in time and energy to become a good investor who equates the quality and amount of hands-on research with the expected return. If this isn't your cup of tea, then be content to get a passive, and possibly lower, return but with much less time and work. Graham turned the academic notion of "risk = return" on its head. For him, "Work = Return". The more work you put into your investments, the higher your return should be." (http://www.investopedia.com/articles/basics/07/grahamprinciples.asp)

Many a questionnaire exists with the supposed purpose of allowing us to assess our risk profile. However, we should treat such questionnaires with scepticism and caution:

"My advice is never to rely on a risk profile questionnaire to tell you how much you should have in the market.In good times, try to pick an allocation a bit more conservative than you might feel. In bad times, try to push yourself to take a little more risk. Once you pick the allocation, however, stick to it. A consistent portfolio of 50 percent stocks and 50 percent fixed income will almost always, in the long-run, outperform a portfolio that averages 50 percent in each but moves into and out of the market." (http://moneywatch.bnet.com/investing/blog/irrational-investor/the-risk-of-taking-a-risk-profile-questionnaire/514/)

This is because everyone likes to think that they are courageous – which in the language of the stock market, translates to having ‘a high tolerance for risk’:

"Whenever anyone asks you, you always say you have a "high tolerance for risk." After all, you like longshots at the track and you never hesitate to buy a stock that you think will go up, even if the experts call it "risky." If your portfolio drops 30 percent over the next year, what are you most likely to do?" -- http://money.cnn.com/quizzes/2007/moneymag/wiredforwealth/index.html

The key is not to get excited about investing. After all, the share market is a highly emotional (or 'sentiment') driven industry that should be approached strictly with logic. If you consider yourself financially savvy, and think that money is sexy, be afraid:

"we have difficulty admitting our lack of knowledge about finances; we overestimate our own wisdom and performance; and our preference for mistakes of action rather than inaction often leads us to irrational investment decisions. Most tellingly, humans believe we're smart enough to forecast the future even when we have been explicitly told that it is unpredictable. Among the book's fun facts: the MRI brain scan of a cocaine addict is virtually identical to that of someone who thinks he is about to make money." (http://www.amazon.com/Your-Money-Brain-Science-Neuroeconomics/dp/0743276698/)

And if you really do think that you know what the market is going to do, consider the following scenario:

"In Year One, Weeds.com earns $2.50 per share. In Year Two, it earns $5 per share. In Year Three, it earns $10 per share. What is your best estimate of what Weeds.com will earn in Year Four?" (http://money.cnn.com/quizzes/2007/moneymag/wiredforwealth/index.html )

The correct answer isn't $20 - that is, noticing that it's doubling every year - but rather 'How the hell should I know?'

There’s also the discrepancy between what a financial advisers or their questionnaires will tell us about our risk profile – and what, after careful and honest reflection, we assess ourselves to be.

Consider how one questionnaire describes me:

“You are an Assertive investor, probably earning sufficient income to invest most funds for capital growth. Prepared to accept higher volatility and moderate risks, your primary concern is to accumulate assets over the medium to long term. You require a balanced portfolio, but more aggressive investments may be included.” (http://www.docstoc.com/docs/21533924/Client-questionnaire-and-risk-profile )

Certainly I want to think of myself as someone with patience, discipline, and foresightedness - young enough that I can hide away my money into some game and not expect returns for another thirty, or even forty years.

Yet I also know that I have to be assured all my money can't just magically vanish in the end. The most important thing for me is that I have to be happy to invest into whatever class of fund I use early, regularly, enthusiastically and for a very good duration in order to get a good capital growth. For instance, I suspect that it would be much better returns if every month I have an automatic deduction from my savings account to my term deposit account, knowing that I'll get all of it back and a little bit more - compared to occasionally getting the courage to make some investment into a managed fund, even an index fund. Psychologically, it's just a lot easier for me, and I'm more likely to have a good savings habit that way.

Furthermore, I won’t accept an investment that is emotionally too expensive for me. For instance, I'd happily sacrifice a few thousand, maybe a few tens of thousands, in my retirement fund at maturity if it means that I'm not kept awake at night, or sweating whenever there's some scary news on television.

Peace of mind might actually be much more valuable to me than that extra money.
Post a Comment