I have often observed that humans are crazy. We all do goofy things for goofy reasons sometimes. It’s part of what makes us humans. We are not always rational.
If you study personal finance, you have probably come across references to irrational investors. Traditional economics describes human behavior based on rational choices made based on good information. Most humans don’t always get great information and often don’t make rational choices. Most of us are irrational investors.
In recent years there has been an increased study of human behavior as it relates to financial choices. Academics call this area of study behavioral finance. It looks at the interaction of human cognitive biases and financial planning choices.
Anchoring is one cognitive bias that is very common in financial planning. Anchoring is when a person fixes on irrelevant information to make future decisions. For investors, we often anchor our thinking to things like the purchase price of an investment, or the most recent all-time high price.
Here’s what this looks like in your financial life.
- You recently left a long-time job and rolled over your 401(k) from your work into your traditional IRA.
- You purchase a group of investments
- Then the market fell by 15% in 90 days.
If you anchor your thinking to the amount of the rollover, you can easily be discouraged by the fact that your retirement nest egg has just shrunk by 15%.
But if you reflect on the fact that you spent 30 working years accumulating your 401(k) balance you might see something different:
- You saved $10,000 each year for 30 years.
- You averaged 7% growth on that money
- You saved a total of $300,000.
- You accumulated a 401(k) valued at about $1,000,000 after investment growth and reinvested dividends.
So, even if your $1 million IRA is only worth $850,000 today, it’s still grown by $550,000 from what you saved.
And if you are retiring in your 60s, you will likely need a bunch of this money to last 35 years or so. Therefore, it should be invested in stocks and should keep growing at an average of 7% a year, even after this temporary 15% pullback.
So, it takes a very intentional frame of mind to keep your perspective as you look at investment performance. It will ALWAYS be easy to hold up the wrong mental measuring stick as you evaluate your situation. And when it’s your nest egg intended to fund your retirement, it gets even harder to keep the proper perspective.
So, maybe you would benefit from the counsel of an experienced, well-trained CERTIFIED FINANCIAL PLANNER™ professional. The perspective of a trained professional who is acting as a fiduciary advisor – that is, your advocate who is legally bound to pursue your best interests – can be a huge help to ensure an effective financial planning process.
If you would like to talk with me about how anchoring basis is affecting your financial planning, I would be honored to be of help. Just follow this LINK to find a time that works for you.
Yes, I am a CFP® professional. I’m always a fiduciary and I work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
If this article has you thinking about your own circumstances, contact my office at firstname.lastname@example.org. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.