Before investing: Know thyself
So you’ve finally saved enough money to start investing? Congratulations! But before you begin filling out your investor profile with your banker, take the time to reflect and be sure of your means, priorities, goals and values. myLIFE is here to help you with this essential step before you dive in.
We are continually influenced by our own biases, be it in daily life or when making important investment decisions. If you aren’t aware of this, the consequences can be dire, particularly when creating your investor profile. How can you build a reliable profile if the choices you’ve made are too subjective and don’t actually correspond to what you want and how you live? It’s true that your banker will ask you the right questions when setting your investor profile, which is a legal requirement of the 2018 EU directive MiFID II, among other regulations. They will help you decide what kind of investor you are:
- more conservative, suited for safer, more defensive investments
- balanced between safety and risk
- more speculative, willing to take greater risks for potentially higher returns.
But there’s a catch. Even if your banker asks the right questions, they can’t detect your innermost feelings or which biases may be affecting your choices. Only you can give them the real answers! This means you’ll need to have taken time to reflect on your means, priorities and goals, as well as your personality and values.
How can you be sure that you’re making the right choice?
One person, but two investors!
Filling out a questionnaire to determine your investor profile is much more complicated than it seems. It’s not always easy to know what our investment preferences are, especially since they can change over time. It can also be difficult to envision the future, because the means at our disposal and our knowledge of financial products will also vary. This is why you will have to update your investor profile periodically. But be careful when you do so: our decisions are often affected by our own perceptions, which can compromise our judgement.
Sometimes we let our emotions decide for us, which makes it more difficult to achieve our long-term goals.
Sometimes we have the desire to invest, sometimes we feel we should build savings, and sometimes we just want to save enough money to buy ourselves a little treat. Faced with a changing will, we may sometimes let our emotions decide for us, making it more difficult to achieve our long-term goals.
It’s important that you’re conscious of your weaknesses when it comes to managing money. Are we really in control of our own finances, or are we sometimes led by emotion to make unwise decisions? For example, if you’re currently financially stable, but are planning a risky business venture in the near future, you might find you need that money you were so eager to invest when things take a turn for the worse. In this situation, even if you’re more of a go-getter, it might be smarter to choose a conservative investor profile that will better protect your quality of life from the uncertainties of a future financial reality that you “forgot” to discuss with your banker.
You are actually two different investors, and it’s up to you to decide which one gets to make the decisions at any given time.
Economists have tried to identify archetypes that describe how we vacillate between immediate consumption, investing, and long-term savings. Richard Thaler, winner of the 2017 Nobel Prize in Economic Science, said that there is a “farsighted Planner” and “impulsive Doer” within each of us. The Planner’s economic choices are sophisticated, whereas the Doer’s are naive. That means you are actually two different investors, and it’s up to you to decide which one gets to make the decisions at any given time.
A sophisticated investor is not necessarily more educated than a naive one. An investor is sophisticated if they are aware that they sometimes have issues with self-control, their preferences vary, and their financial choices may be influenced by their behaviour. They put safeguards in place to protect themselves from potential mistakes and ask experts for advice.
A naive investor, by contrast, does not take all of this into account, so they tend to be overly optimistic about their ability to self-regulate. They prefer doing things themselves and following their intuition. They also overestimate how reliable their judgement is. This may lead them to be overly impulsive at times, and procrastinate at others (when it comes to savings, for example). All of this adds up to delayed short-term reactions, unnecessary risk-taking in the medium term, and less-than-effective decision-making in the long term.
It’s not about a lack of education or the inability to make good financial decisions, but rather learning to be honest with yourself and better understanding your relationship with money in order to invest appropriately. So what should you do? You really need to take the time to develop this understanding, or your naiveté will come back to haunt you. In the meantime, here is some advice to get you mentally prepared for filling out your investor profile with your banker.
Ask yourself tough questions about your relationship with risk
Your investment choices will affect you emotionally as well as financially. You should take both of these aspects into account to determine your relationship with risk and what the right investment decisions are for you.
First ask yourself why you want to invest. Is it for short-term earnings, so you can finance a specific project, or to improve your long-term finances?
Then, imagine what will happen once you’ve made that choice. For example, if you choose a long-term investment, imagine yourself investing in the same product for several years, or even several decades. That way, you can mentally prepare yourself not to overreact to short-term market volatility. Instead of focusing on what’s changing right now, try to keep the bigger picture in mind: the overall impact of your investments on your long-term wealth.
To determine if a given investment situation is the right choice for you, you need to be able to think in terms of overall well-being and lifestyle.
Did this mental exercise make you realise that you’re uncomfortable with the idea of extreme volatility? Excellent, you’ve just learned something important about yourself. To determine if a given investment situation is the right choice for you, you need to be able to think in terms of overall well-being and lifestyle. If you can’t live your daily life comfortably with uncertain finances, a high-risk profile is definitely not for you.
In other words, are your regrets more likely to be investment opportunities you let pass you by, or bad investments you decided to go for? You are probably better at navigating risk in the first case than the second.
Finally, the most important thing not to lose sight of is the purpose of investing in the first place, which should be to maximise your overall well-being. This includes your personal, emotional, and financial well-being, meaning you should never make decisions that will throw off the balance between your life goals, investments, and emotional state. Money may not buy happiness, but it can certainly help.
Before you even start thinking about investing, maybe it’s time to ask yourself if you consider money to be a means to an end, or an end in itself. An honest answer to this question will help you understand what money really means to you (security, freedom or something else) and which emotions you associate with it. This information will help you find your path as an investor.
Now you’re ready to fill out your investor profile with your banker. Don’t forget that risk appetite is only one aspect of the profile and other factors, such as your knowledge and experience, financial status, investment horizons and life plans can limit, or even completely override it.
At the end of the day, finding the right investment strategy depends on how well you know yourself.