Behavioral economics is a rapidly growing field of study. A component of this, behavioral finance, is a primary area of focus in the academic circles of the financial planning profession. As such, I thought you might find this interesting.
The brain has a lot of gray matter but dislikes gray areas. As a planning machine, the brain needs information that is certain so it can figure out the best course of action. And when we don’t get certain information, we tend to feel unsettled. Perhaps you have thought to yourself, “I don’t care if the news is good or bad, just tell me what it is. Not knowing is the worst.”
Probability Problem
Whenever there is uncertainty (almost always) we must rely on probabilities to help us make the best decision. Probabilities require a lot of thought and analysis. It means we have to think statistically, which many of us prefer not to do. Further, accurate and unbiased data can be difficult to obtain in our soundbite society. Thus, many tend to simplify probabilities whenever possible.
Remember the election of 2016? It was said that the election polling was wrong because Trump won. However, the polls were giving Trump approximately a 30% chance of winning. The problem is that our brains will generally take a low probability and simplify it to zero.
We all want to know what is going to happen in the markets. In the face of uncertainty, we seek out some degree of certainty – even an illusion of certainty. People are attracted to forecasters and market experts who will tell us what is going to happen. Their popularity and confidence tends to be construed as their ability to predict the future.
Investing Takeaway
The truth is we can think of a lot of things that have occurred that cause investors and “experts” alike to scratch their heads. Surprises and uncertainty are just about the only certainty in the financial markets.
We can’t control the markets or the economy. We can’t rely on expert forecasts, no matter how confident they sound. Even those forecasts with low or high probabilities aren’t sure things – sometimes the unexpected happens.
But, we can control how we respond… the choices we make. A financial plan provides guidance and structure. It needs to be coupled with sensible behavioral discipline – how we will respond to the inevitable uncertainties and surprises. That’s what I am here for.
Let’s focus our time and energy this election season on those things we can control. As always, we are here to help should you wish to discuss this or any other matter. If you think others would find this interesting, please share it.