Perfection in financial planning is impossible and its pursuit may actually be counterproductive. It may be better said that financial planning is fundamentally an exercise in mistake management and minimization.
Much like major league batters in baseball, three-point shooters in basketball, and football quarterbacks in pursuit of completing passes, you may well fall short more often than hitting the mark. Case in point, specifically related to investing (and the Russell 3000 index from 1983 through 2006): just 25% of stocks were responsible for all the market’s gains!
These inconsistencies are simply a fundamental part of investing in collective and competitive free markets—but what about us, individually? Well, the field of behavioral economics has proven that more than a century of traditional economic theory was based on a fundamentally flawed assumption, that we, as humans, would function rationally in financial decision-making.
The truth is that most of our decisions, financial or otherwise, are triggered by our System 1, impulsive, instinctive, often-irrational, fast-thinking core processor in our brains—our gut, if you will. And then we use our more thoughtful, procedural, slower-thinking, System 2 processor to rationalize the decision we just made.
And if you doubt that this is the case for you, please consider that this dynamic is likely the only reason we ever “needed” that restaurant-worthy double oven, the commercial-grade zero-turn lawnmower, the 80-inch high-def TV, the car that goes from 0-to-60 in 2.9 seconds, or the trendy shoes that somehow help the environment and bring about world peace if we only buy them off of Instagram. (I’m guilty of at least one—guess which…)
It’s not so much that we, as humans, are fundamentally flawed—but that we are fundamentally complex; that we cannot separate ourselves from our emotions; that we are body, mind and spirit. It’s a beautiful, messy conundrum.
So, for starters, please feel free to forgive yourself for the many financial foibles you’ve committed to date. And please know that there’s also a way to make the most of your mistakes. Here’s how:
1) Reflect on your experiences. John Dewey said, “We do not learn from experience…we learn from reflecting on experience.” However impulsively we might act in the moment, we have an opportunity to engage our rationale in the moment or moments that follow. Through reflection, followed by the formation of habits and creation of defaults (see next point), we are capable of effectively re-training our future behavior.
While it was once a natural part of life, reflection is something that we don’t do much of these days, predominantly because every moment of pause is immediately filled by some form of stimulation, most often deriving from our smart phones, tablets or the aforementioned 80-inch high-def TV.
But it’s also true that we seem to perceive time spent thinking as time wasted. It’s ironic, then, that some of the world’s highest performers have gone so far as to schedule time just to think. And if you’re easily distracted like me, it may help to use a journal, both to catalyze and visualize your thoughts.
2) Form habits and set defaults. Once you’ve reflected on a past mistake, one of the most helpful ways to avoid repeating it is to form a new habit and/or set a new default. For example, if you always spend too much on groceries when you go to the store, buy your groceries online, so before you check out, you can see the actual amount that you’re spending and make changes as necessary.
Or suppose you’re struggling to increase your retirement plan contributions because you’ll see reduced cash in your paycheck today; create a default with your 401(k) provider that will automatically increase your retirement plan contributions by 1% each year, coinciding with your regularly scheduled cost-of-living raise. (It’s easier for us to pledge money we haven’t yet received than money that is in our possession.)
We can work with our own psyches instead of against them.
3) Build margin. And perhaps most importantly, since we’re “predictably irrational,” it’s helpful to plan in advance for our money mistakes that are sure to come. This is the greatest benefit to come from the discipline of budgeting—that you don’t have to endure the stress of living paycheck-to-paycheck, simply by establishing a buffer of savings. It’s great to get this started with some unexpected found money (your tax return, a small inheritance, an unexpected gift or bonus), but consider also establishing a monthly amount that automatically funds the unexpected.
You’re not going to bat a thousand, hit all your three-pointers, complete all your passes, or navigate life in a way that is financially flawless. But progress, not perfection, is the goal, and you can make the most of your mistakes…if you choose to do so.