Can you be too cautious with your finances?
Research has show how being cautious with pension investments can be as damaging as taking too much risk. In some cases, a cautious approach is appropriate. Whereas in others, it’s the result of our subconscious financial bias affecting our decisions.
Research from Cass Business School discovered that women are more risk-averse than men. It’s a trend that may well be affecting how much women have in their pensions and other investments. The research also found that young people and those that are single are more likely to be risk-averse too.
Professor David Black, co-author of the paper and Director of the Pensions Institute at Cass, said: “Women, because they are more risk-averse than men, would be more comfortable with lower-risk investments. Over a long investment period, such as that involved in building up a pension pot, this behaviour has been described as ‘reckless conservatism’ – women with the same salary history as men, on average, would have lower pensions as a result.
“On the other hand, men’s investment overconfidence can lead to ‘reckless adventurism’. This is not necessarily desirable at older ages close to retirement, since there is less time to recover from a severe fall in stock markets.”
What is financial bias?
Financial bias is quite simply a human tendency that affects our perspective and behaviour. These may be based on beliefs and experiences. In financial terms, bias can affect your ability to make decisions objectively. For instance, you could make a choice based on emotional bias rather than evidence.
As the example above; why are women more likely to take less risk with investments? It’s likely that bias is having an impact. Whilst the research didn’t indicate their personal circumstances, pre-conceived ideas will be affecting some women when they decide how much risk to take.
There are lots of forms of financial bias that may affect your decisions, they include:
1. Loss aversion
This is the financial bias that the research above looked at. It’s an emotional tendency to prefer avoiding losses over making gains. Past research has indicated that the pain of losses is greater than the pleasure of gains. As a result, investors may select lower-risk options than appropriate to avoid losses.
Another example of loss aversion is the sale of falling stocks earlier than planned to help prevent further losses. Whilst doing so could protect you from further falls, it can be damaging. Selling stocks and shares can effectively lock in your losses. Remember though, over the long term, investments typically deliver returns.
2. Confirmation bias
For example, you’re looking at pension opportunities and decide one option is too high risk. But you decide to do some research anyway. Confirmation bias leads you to seek out information that supports your view. So, you would discard the figures that suggest it could actually suit you. As a result, research will simply back up what you already believe.
Confirmation bias may lead to a one-sided financial view. It can make it difficult to objectively balance the pros and cons. By simply being aware of this can help to improve your research process, as can working with a financial planner.
3. Herd behaviour
If you have ever found your action imitating those of a larger group, herd behaviour could be to blame. In some instances, it’s right to follow what others are doing. But it should align with your own reasoning, plans and wider goals. With so much going on in investment markets, it can be hard to focus on what’s right for you.
For example, should markets start to decline, you may pull out of investments if others are doing so. This is because you believe that a group majority must be right. Yet, their circumstances and aspirations may be very different from yours. It’s important to build a financial plan you have the confidence to stick to.
How can financial planning help?
Working with a financial planner can help you to remove some of your bias from your financial decisions. It allows you to view your options through another’s eyes. You may have a clear idea about the best way to invest for retirement, for example. But after talking it through with a financial planner, you will have a better idea whether taking more or less risk is appropriate.
Financial bias can also mean making rash decisions. For example, when the value of stocks begins to drop you may consider selling. Having a long-term financial plan in place may give you the confidence needed to hold steady. This, in turn, can help you keep on track to achieve your goals.