When I first began working as a financial advisor, I was convinced the correct answers were in the numbers. Put together a plan, determine a savings rate, hang on through the ups and downs of the market and voila – success! I was as naive as those economists who base beautiful theories on the existence of homo economicus, the rational human being who carefully calibrates his wants and needs before making an emotionless economic decision.
Fast forward these dozen plus years, and it is now clear to me that a successful plan begins with a simple dictum – know thyself (or, in my case, know thy client). Every individual has a unique money personality, and while providing a carefully constructed, stress tested plan with clearly defined inputs and outputs and an equity heavy portfolio may work for some clients, it certainly isn’t one size fits all.
We’ve retooled our planning process to include an assessment that helps us understand several key factors for each client. Regardless of whether or not you approach determining your money personality as systematically as we do, there are a few factors you should consider:
Risk Tolerance – risk tolerance is defined as both the willingness and the ability to accept risk. There are a number of inputs that help determine both facets of risk tolerance, but the bottom line is that if your portfolio is not in line with your risk tolerance, at some point in the market cycle, you’re likely to be disappointed at best or, at worst, pull out of a bear market due to losses.
Cognitive Biases – I’ve written a good bit about cognitive biases in the past (see here, here, here, here and here), but it is because investor behavior has such a large impact on returns. Our biases – often tied to mental shortcuts we take – generally have a negative impact on returns, so understanding what your particular biases are can help you recognize them and avoid them when they come into play.
Decision making style – while you are likely aware of your decision making style, it is helpful for us as advisors to understand what your particular style. Do you tend to make decisions deliberately, or do you review all the data and quickly make a decision? When it comes to communication, are you more visual or verbally focused? Understanding these and other factors allows us to provide you the information and time you need to make decisions with you are comfortable.
How you mesh with your partner – it is rare that couples’ money personality match perfectly, so you should take the time to explore each of the above issues with your partner. We’ve found that taking the time to do this at the outset of planning leads to stronger financial goals and less disagreement as you pursue those goals.
While the core of a plan is the mathematical model on which I focused when I first began my career as a financial advisor, how you interact with that model depends upon your money personality. Taking the time to understand your personality – and that of your partner if applicable – greatly increases the likelihood that you’ll feel comfortable implementing the plan over the long run.