Truth used to be an absolute.
As a child, I was often asked “Are you telling the truth?” and there was no two ways about it.
But truth today is subjective; everyone has their version, hence the expression “speak your truth”.
The lines between truth and belief have been blurred, which has consequences for every part of life including financial planning.
Consider the current COVID-19 vaccine debate. The resistance of some and the outright refusal of others to get vaccinated has revealed far less social cohesion on this matter than assumed.
For many, the reasons behind their vaccine hesitancy are valid and rational. Their decision is normal.
Similarly, the reasons why some people insist on accumulating Bitcoin and investment properties, despite the risks, may be misinformed but to them, their logic is sound.
The study of behavioural finance aims to identify biases (or repeatable errors) that lead to conflict between the rational expectations of economists and the real-life experience of individuals.
The subtext is that if people can identify and understand their biases, they won’t make mistakes.
However, even famed economist and Nobel Prize recipient Daniel Kahneman openly talks about the common behavioural errors he makes.
This brings us back to the issue of beliefs.
There are three types of beliefs: factual, preference-based and ideology-based.
Factual beliefs refer to knowledge that is based on an objective definition such as the sun is hot or water is a liquid. Another example could be vaccines prevent death and reduce the risk of serious illness.
Preference-based beliefs are based on some form of cognitive judgment and vary from person to person. An example may be Aussie rules is the best football code or Melbourne is a better place to live than Sydney.
Ideology-based beliefs are probably best exemplified in the context of religion. When it comes to faith, there is often no need for objective facts, although many believers see faith as fact.
The impact of ideology-based beliefs can be seen in financial services, particularly in relation to investing. When investors turn their back on quality assets in favour of speculative fads or shun sound investment principles to borrow such large sums they’re unlikely to ever repay them in their lifetime, their decisions are clearly being impacted by their beliefs.
As financial advisers, we all have beliefs regarding the risk and return characteristics of specific asset classes. For example, there is generally some consensus around the possible returns from Australian equities in next 12 months, with a reasonable tolerance for error.
But retail investors don’t have access to the same data and research as fund managers and advisers. They must do their own research and rely on sources like articles, social media, and friends and family.
As discussed in my article Countering client investment FOMO, online media content is curated for readers based on their internet searches, fuelling confirmation bias.
Someone who has entered crypto-currency or bitcoin into their search engine will start to see related articles in their feed.
If these information sources are deemed credible, beliefs around investment returns start to form. Once beliefs are formed, they are incredibly hard to shake.
Confirmation bias has been described as the mother of all biases. A glaring example of confirmation bias can been seen right now in the United States, where a significant proportion of the population still believe that Donald Trump won the 2020 election and his presidency was stolen. There is little point trying to change their beliefs.
That said, advisers still need to try and influence ill-informed beliefs. It is our role to do so.
To overcome a belief, an alternative needs to be presented without discounting the original belief.
For advisers dealing with a mad-keen property investor, there’s no point arguing that property may not double every seven years. A more effective approach is to point out that no one can live off negative income in retirement and this is an issue that must be properly managed.
Another method is to encourage deeper analysis, as opposed to a heuristic approach. Heuristics are mental shortcuts that influence decision-making.
Instead of refuting a client’s ideology-based beliefs head on, which rarely works, take a mathematical approach.
Ask questions such as, “so this property will be worth this much in seven years?” or “what will the rental return be in seven years?” Go so far as to hand the client a calculator so they can work it out.
Another effective approach is to get the client focused on their overall long-term goals and then see how investing in property or crypto-currency or borrowing eye-watering sums of money might fit into a prudent strategy. A comprehensive master list of goals is an excellent way of correcting tunnel vision.