In financial planning, there are hidden, yet prevalent, enemies that can undermine our financial goals and well-being. You might think these enemies are volatile markets, economic growth, or inflation, but it's actually far more subtle than this. The enemy is, more often us, specifically, the financial behaviours we practice without even realising it. Our unrealised behaviours are what typically lead to overspending, inadequate savings, or other damaging financial decisions. They are behaviours that can derail your financial planning.
Enemy One: Comparative spending
Deeply ingrained in our human behaviour is a psychological phenomenon where we tend to gauge our worth, success, and status by comparing ourselves to others. We look at our colleague’s brand-new luxury car, or a friend’s extravagant vacation, and we assume financial affluence. We tell ourselves a story, and the story is fraught with assumptions that are often not true. This is where the danger lies. In a space where we then respond and model our behaviours based on inaccurate information. What are some of the assumptions we might be making?
- Because she is posting images of herself in Italy she must have paid for the holiday.
- Because she paid for the holiday, she must be rich.
- Because she is in Italy and she is rich, she must be happy.
Of course, we have no idea if she paid for the holiday, what her circumstances were at the time and if she is in fact happy. We might be overlooking serious factors such as debt, stress, well-being, or financial instability!
So why do we compare ourselves to others? Psychologist Leon Festinger believes we do it to establish a benchmark against which we evaluate ourselves. How are we doing relative to others? However, in the modern financial landscape, this primitive instinct can lead to a detrimental spiral - one that results in unsustainable spending and inadequate savings. Especially if you compare yourself to someone better off (“upwards comparison”).
External displays of wealth are not accurate indicators of financial health. Here are some practical steps to help navigate this temptation:
- Set clear and personal financial goals: We are all individuals with our own risk tolerances, income levels and expenses. It’s important to understand these parameters and to set your own objectives and long-term goals. When you follow the influence of others’ spending habits, you can deviate from your own personal goals. Knowing what your goals are will make it easier to stay focused on your own journey and not someone else’s.
- Seek professional advice: It’s not easy to set clear goals. Perhaps you have not have thought about it much or do not understand what you need to action to achieve your goals. A good financial planner can help you clarify your goals and create a roadmap on how to achieve them. Most importantly, a good planner will keep you accountable to those goals.
- Beware lifestyle creep: For many, income and bonuses increase over time, and with that comes the temptation to spend more. In other words, our lifestyle tends to increase with our earnings. Saving additional earnings is a powerful way to achieve your long-term financial goals quicker. However, doing the things you enjoy and living a meaningful life today is also important. So, you need to strike a balance between enjoying your lifestyle and increasing your savings. The best way to do this is to save first and then adjust your lifestyle with the remaining funds.
- Gratitude: I think one of the most powerful ways to deflect comparing yourself to others is to practice gratitude for what you do have. We tend to compare ourselves to people who seem more successful, but there are so many who have less than we do (“downwards comparison”). By choosing to focus on gratitude, you will find it much easier to stick to your own goals.
Enemy Two: Projecting future wealth
As financial planners, a common predicament we encounter is how to adequately prepare clients for a future that is inherently unpredictable. When clients are in the wealth accumulation phase of their lives, there is a tendency to extrapolate current financial patterns and earnings into the future. In other words, we think our financial position today will be the same, if not better, going forward. This is especially true of younger clients who are climbing the corporate ladder or building successful businesses. Although this strategy seems to make sense and is practical, it is also riddled with pitfalls.
Financial plans are typically built on at least three presumptions:
- Clients will continue saving at their current rate.
- Client incomes will persist.
- Bonuses will flow regularly.
These presumptions are projected into the future to help us establish what is needed to achieve personal goals. While this forms a foundation for planning, it doesn’t account for life’s inherent unpredictability. In South Africa and globally, job losses occur, struggling businesses cut bonuses, businesses close down, or unforeseen early retirements are offered to people in their late 50’s. All these events can disrupt and devastate well-laid financial or retirement plans, and cause a lot of emotional distress.
How can we navigate uncertainty best? Here are a few practical principles to apply:
- Financial goals can be adapted: If you understand your goals and how to achieve them over time, it’s easier to identify moments of pause so you can adjust. Any good financial plan and trusted advisor can help you adapt. Having this technical and emotional support and guidance can reduce a lot of anxiety. Importantly be kind to yourself. These things happen, so don’t panic as adjustments can be made.
- Understand your budget: Know exactly what your fixed and variable expenses are. You can quickly reduce variable expenses if needed. Fixed expenses are often a necessity. Most importantly, budgeting helps you live within your means.
- Emergency funds: We always suggest keeping 6-12 months’ worth of living expenses in cash. This can be held in a separate bank account, or if you have an access bond, this could be a useful place to access cash quickly. This is important because:
- It buys you time, to assess and adjust where needed.
- Helps cover the fixed expenses (discussed in point above).
- You don’t have to liquidate any savings or pension funds to cover these expenses. Sometimes people are forced to cash in a pension fund to fund expenses and this jeopardizes your retirement planning.
- Insurance: Certain insurance policies can provide much-needed relief, especially in the case of unforeseen medical complications that affect your ability to earn.
- Conservative assumptions: As financial planners, we prefer using conservative assumptions when planning for our clients. We often exclude discretionary bonuses and use lower expected returns when projecting future values. This helps build a buffer for when changes are required
In conclusion, I believe financial planners are uniquely positioned to help clients navigate both the obvious and unseen enemies. This is why part of the role of a good financial planner is to help their clients build awareness around behavioural issues such as comparative spending. By doing this, clients can navigate toward a financially secure and fulfilling life, unswayed by the illusory benchmarks set by others.
At Foundation, we work to ensure that our clients' portfolios are well structured for a financially secure future, but also, that they’re equipped to navigate the uncertainties that life invariably presents.
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