Every time we decide to buy a cup of coffee, take on an online subscription or do our shopping, we are making financial decisions. Along the years, we become experts at this type of short-term (everyday) planning. Decisions such as paying with a debit or credit card become habits.
The situation is entirely different when we undertake mid-term (e.g., buy a car) or long-term financial decisions (e.g., plan for retirement). Our financial expertise regarding these choices declines sharply as our capacity to predict future needs is limited. To overcome these obstacles, we need to undertake financial planning. That is, to develop strategies to best utilise our skills and resources in pursuit of our financial goals.
Unfortunately, evidence reveals that we have serious troubles to engage in long-term planning activities. Take, for instance, retirement planning. In the UK, 35% of the population claim that they don’t have a pension and 43% acknowledges that they do not know how much pension income they will need for retirement. Even more worrying is the fact that the amount required to retire comfortably starts around £260,000 and that more than half of the UK population believes that £100,000 will be enough for a pleasant retirement.
Why do people find so difficult to plan for their future?
Jump to Section
- Decisions and behavioural inclinations
- Stress and Anxiety in Financial Planning
- Change the Context to Change Your Emotions
- Coach Yourself to Become a Better Planner
- How can this framework be applied to financial planning when it comes to retirement?
- Virtues of Coaching on Financial Planning
1. Decisions and Behavioural Inclinations
As humans, and probably due to our short evolutionary history where the focus prevailed on survival, we possess ingrained behaviours that overemphasise the present and neglect the future. And, when we do project ourselves into the future, we appear unprepared as we lack the skills to plan to take appropriate action.
A possible explanation of this behaviour is that our nature seems to prompt us to perform activities that offer immediate rewards. Because of the satisfaction carried out by present recompenses, we tend to dismiss unpleasant or tedious tasks which may, nevertheless, bring better outcomes in the future. For example, we tend to spend our money to indulge ourselves now rather than save it for later. Because the rewards of delayed benefits go unnoticed, we do not experience enough satisfaction saving for our future wellbeing. Financial planning could be associated with the absence of present rewards since our current income is taken away from us for a future and remote cause. As a consequence, the planning activity is perceived as unpleasant, stressful and is then avoided.
Another factor that influences financial planning is uncertainty, an element that is at odds with planning. Think, for instance, about the unpredictable situation created by the COVID-19 pandemic, a period where our plans need to be constantly reviewed. Likewise, financial planning is jeopardised with uncertainty caused by market movements (e.g., the COVID-19 pandemic), political turmoil (e.g., the Brexit), job losses, health issues, and so on. This instability elicits high levels of anxiety which make people scared of taking wrong decisions susceptible to cause financial losses. Thus, we prefer to delay decisions affecting long-term planning and wait for more stable conditions, which may never come.
The considerable level of knowledge and expertise required to make informed financial decisions is another element affecting financial planning. To plan for retirement, people need to calculate the contribution necessary to get an appropriate retirement income, assess future spending needs, understand the potential health and care costs, choose between financial products, and so on. Briefly, individuals need to estimate whether their future pension will be sufficient to maintain a comfortable lifestyle after retirement and what they need to adapt to reach this target. The magnitude of the task reunites the conditions for a perfect cocktail of anxiety and stress that undermines any motivation to take action.
It is worthwhile noticing that the negative emotional reaction elicited by complex financial contexts will also affect the decisions made during the planning activity. Negative emotions play a crucial role in our perception of rewards, uncertainty and motivation.
2. Stress and Anxiety in Financial Planning
From an evolutionary perspective, stress and anxiety are adaptive responses intended to preserve our lives. For instance, stress increases alertness to help us to detect threats in a dark alleyway. In turbulent market periods, stress increases the alertness and attention necessary to identify suspicious market drawdowns and take action (e.g., sell part of an investment). However, in other situations, these states may trigger detrimental and maladaptive responses that cause panic reactions so that investors end up selling their assets.
A primary function of emotions is valuation. Emotions inform our brain which option is more desirable and satisfactory among a series of choices, that is, more rewarding. For instance, we decide to eat a piece of chocolate rather than an apple because the feeling of pleasure eating the former is greater than the latter. The positive feelings elicited by chocolate carries more weight in the decision-making process influencing its outcome.
A negative emotional appraisal also influences decisions, but in the opposite way. If one of the choice options elicits a stress reaction, the negative valuation of this option leads the brain to avoid it. Financial planning falls under this category. Imagine that we need to decide whether we start planning for our future or we watch a movie. Because planning involves effort, time, and uncertainty, it triggers stress. Due to the negative valuation associated with planning the best option is to avoid unpleasant feelings by avoiding planning. Instead, we choose to watch a movie, a more rewarding choice.
When it comes to decisions, anxiety also has detrimental effects on decisions. It deviates our attention from relevant information and put too much weight on negative items. As we saw earlier, market movements, political turmoil, and our limited financial knowledge are all reasons to amplify anxiety levels. If that happens and we feel nervous, the impartial evaluation of information during a decision will be altered by anxiety. Anxiety will deviate our attention toward negative aspects highlighting potentially unfavourable outcomes. As a result, our perception of risk and uncertainty will increase.
The effort required to make informed financial decisions can also increase negative affects. Due to the complexity of information, unpleasant states associated with the idea of making financial mistakes susceptible of causing losses in wealth are pervasive. The consequence is that engagement and motivation, two crucial elements to undertake long-term planning, decline dramatically.
3. Change the Context to Change Your Emotions
As we can see, stress and anxiety affect financial planning activities because they prevent us from perceiving rewards, increase our perception of risk and uncertainty, and lower our engagement and motivation.
So, what can we do to reduce the negative impact of these states on our decisions?
There is a simple answer: redesigning our surrounding world.
A relevant fact about affects is that they are malleable. That is, we can alter our emotions by changing our context. For instance, someone who feels sad could choose to cheer them up watching a comedy. By changing the external conditions (our surrounding world) we can modify internal states (e.g., induce positive effects) and thus influence our decisions.
Coming back to planning, if the task is presented as long, tedious and overwhelming, it will elicit negative feelings and be perceived as undesirable. However, if the task is simple and inherently rewarding, it will elicit positive feelings and become attractive.
Then, how can we redesign the financial planning context?
Again, there is a simple answer: divide and conquer.
Breaking down the planning activity into its small components has crucial benefits. It reduces the amount of time and effort required, makes the task more enjoyable and rewarding and keeps us motivated and engaged in this task.
4. Coach Yourself to Become a Better Planner
To deal with financial planning, we need to redesign financial planning tasks to make them simpler, concise, and enjoyable.
There is a simple coaching framework called SMART goals that we can apply to help ourselves to deal with financial planning. “SMART” is an acronym that stands for Specific, Measurable, Achievable, Relevant and Time-Bound.
Specific: Make your goals simple and specific.
Measurable: Measure your progress with evidence.
Achievable: Make sure the task is such that you can achieve your goal.
Relevant: Set up realistic goals that align with your possibilities.
Time-Bound: Set a reasonable deadline.
5. How can this framework be applied to financial planning when it comes to retirement?
Retirement planning involves several stages: comprehend the different types of pensions, understand future financial needs, calculate the required retirement income, estimate tax relief on pension contributions, choose among available products, or turn to advisory services for help, to mention only a few. Taking all these elements together makes the task look almost impossible. However, if we take each step as an independent and individual goal, financial planning becomes more appealing.
Remember the introduction to this article, I mentioned that we become experts in making short-term financial decisions and everyday planning turns into a habit. By taking each step as a goal, we intend to appeal to our short-term planning expertise and eventually convert long-term planning into a habit as well.
Let’s imagine that we focus on types of pensions as our first goal. The application of the SMART framework will look like this:
- Specific: Your goal is simple and specific as you solely scrutinise the types of pensions available.
- Measurable: You can measure your progress by making a checklist of the types of pensions (e.g., state, defined benefit, defined contribution) and learn about each of them.
- Achievable: Make your goal as simple and easy as possible will help you to obtain a sense of achievement. You could, for instance, only focus on government websites.
- Relevant: You can allocate only a few hours a week to the task to avoid conflicts with your everyday life activities.
- Time-bound: Set an end-date that allows you as much time as you need without making it too long. You might want to dedicate one month to this goal.
6. Virtues of Coaching on Financial Planning
Applying the SMART framework has several virtues.
Taking a specific goal makes the task manageable and enjoyable. Negative emotional reactions such as stress and anxiety will be minimised and the task will not be perceived as difficult and unpleasant.
Being able to measure progression allows us to perceive rewards. The completion of each small step can be tracked over time which allows us to be aware of our progress. Each small achievement will be perceived as a reward.
Undertaking small tasks makes it achievable reducing stress and uncertainty. Simplifying the task will radically minimise the feeling of stress. As a consequence, the threat of uncertainty slowly fades away.
Making it relevant and realistic prevents the goal from colliding with our everyday activities. This will boost our engagement and motivation since the planning task fits in perfectly with other personal projects.
Likewise, setting up a deadline increases motivation and engagement. A key aspect of undertaking a learning activity, like an online course, is to be able to finish it. The deadline represents the end of our efforts. The accomplishment of the goal is a source of motivation that helps us to carry on with the next step in retirement planning.
As we can see, financial planning is not arduous, the application of simple coaching techniques can convert it in an engaging project. Furthermore, observe that although the focus of long-term planning in this article was retirement, the same argument applies to innumerable situations, even beyond the financial domain. Adapting our surrounding world to a more compatible context with our human nature helps us to modulate our emotions and find the necessary motivation to undertake any financial planning activity.
This article was written by Ariel Cecchi Head of Research at Be-IQ Ltd.
Ariel is a Behavioural Scientist and researcher in Experimental Psychology at University College London (UCL).
He works on the design of instruments to assess and mitigate psychological biases in consumers and practitioners with the objective of improving consumer’s financial well-being.
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