In a perfect world, people make rational, logical decisions when it comes to their daily finances. According to organizational behavior theory, the concept of rational decision-making is based on obtaining a detailed idea of the problem; – carefully evaluating potential alternatives; – choosing the best possible option based on objective assessment criteria and finally monitoring the results.
Unfortunately, organizational behavior theory also states that rational decision making is an ideal. In reality, many factors hinder people’s ability to make the best possible choice at all times. These factors include imperfect and incomplete information, complex problems, uncertainty, our own limited processing capacity, time constraints, conflicting goals of decision makers, lack of agreed criteria, foolishness, and error.
Then, based on this reasoning, we can assume that there are many pitfalls that people can step into when managing their personal finances. In search of potential ways to mitigate these pitfalls, Morgan Housel’s bestselling book, “The Psychology of Money”, offers some valuable insights.
Here is a 10-point summary:
- Behaviour Beats Skill: Housel argues that success in investing is often more about controlling one’s emotions and behaviour versus having superior financial knowledge or skills.
- Define Wealth Personally: There are various aspects that influence the way people look at the world. Some people see a deep shade of blue, while others might see purple. The same is true for perceptions regarding wealth. According to Housel, true wealth is highly subjective. True wealth, he argues, is about having the freedom and flexibility to live life on one’s own terms, aligning with personal values and goals. From a brokerage perspective, this highlights the importance of financial planning that is tailored to individual needs – where specific products are chosen to help clients reach certain goals.
- Long-Term Perspective: Successful investors focus on the long term and understand that time in the market is more critical than timing the market. To demonstrate this in a practical sense, have a look at this video where Delta4 talks to Pierre De Klerk, at Boutique investment Partners about the value of timing the market versus staying invested.
- Compounding is King: Building on the long-term perspective is the compounding argument. In the creation of long-term financial independence and wealth, investors are encouraged to have patience and make consistent contributions. Over time, the compounding effect will step in and allow for substantially larger returns.
- Risk and Volatility: Housel believes that understanding the difference between risk and volatility is crucial to effective financial management. Volatility should be seen as a natural part of investing. This is created by various internal and external factors – such as market movements. However, real risk is the permanent loss of capital.
- Adaptability: Financial success often comes from being adaptable and open to changing strategies as circumstances evolve. At Delta4, one of our core goals is to construct resilient portfolios for our clients – capable of effectively navigating market movements in any season.
- Savings Behaviour: The author suggests that saving money regularly is more important than the size of the investment returns. A high savings rate contributes significantly to financial well-being in the long run.
- Learning from Mistakes: It is important to recognise that mistakes are inevitable. However, in order to unlock personal and financial growth, one must be willing to learn from those mistakes and embrace failure as a learning opportunity. Here, the growth mindset plays a valuable part for investors to change their thinking from fleeing from mistakes to intentionally seeing it as a chance to improve one’s understanding of a certain concept.
- Behavioural Biases: This point links to behavioural finance theory – where it is important for investors to not only recognise their own behavioural biases, but also to act pro-actively to manage them in order to make sound financial decisions. Some common behavioural biases we encounter in the investment sector includes the familiarity bias, loss aversion and herd mentality.
- True Wealth: Housel believes that in essence, true wealth links to having the freedom and flexibility to live life on one’s own terms. Here, his reasoning states that a broader goal than the accumulation of money is to live a life of meaning and impact. This leads to a greater form of fulfilment.
At Delta4, we aim to explore some of these principles with our clients when constructing financial portfolios. We believe that the human-element, so personal needs, experience and reasoning, is central to constructing a resilient financial portfolio because every client’s financial journey is unique.
Written by A. Esterhuizen
(MCom; BComHons – cum laude; BCom)