How Our Human Intuition Undermines Our Financial Well Being
Transcript of How Our Human Intuition Undermines Our Financial Well Being
54 l December 2012 Money Compass
Gavin Teoh is the Founder of CentumSage Advisory, formerly known as EFP
Wealth Advisory, a practice office of Standard Financial Planner Sdn Bhd (SFP). He is a
fee based financial adviser holding a license with Security Commission Malaysia for
financial planning practice under the Capital Markets and Services Act 2007 since 2006.
Gavin is also a licensed financial adviser representative under Insurance (Amendment)
Act 2005. He was appointed as SFP director of advisory and practice management for
this practice office since 2010. A Certified Financial PlannerTM (CFP) since 2002, he is
among the earliest qualified and CFPs in Malaysia during the infancy stage of the
industry. In 2009, he was certified as Islamic Financial Planner, a local certification for
professional Islamic wealth management practice.
When it comes to the area of
managing our wealth, we like to
believe that we can make rational
decisions for our financial well being.
This belief is contrary to what actually
happens from extensive research
done in the area of behavioral
finance. Here are three common
behaviours documented by research-
ers where our human intuition
undermines our financial well being.
Loss AversionThis is a mental short cut we use for
self preservation. On a fundamental
level, it makes sense to avoid loss in
the material world. However, when
investing in the financial markets this
intuition plays havoc with us.
Imagine investing RM10,000 in
shares of a large corporation. You
are told this company is well run and
has good prospects over the next five
years. You bought into the share
yesterday at RM5 per share. One
month down the road, a financial
crisis in Europe causes stock
markets worldwide to plunge. Your
shares fell by more than half to
RM2.20
You panicked and decide to limit
further losses by selling all your
shares. By the end of the year, the
share price of the company has risen
to RM7.80 At that point, you felt the
loss of missing out on the RM2.80
you could have gained had you
stayed put during the European
financial crisis.
So, you decided to buy the shares
again. Rationally, you knew that to
make money in shares, you should
buy low and sell high. However, due
to loss aversion, which is a built-in
intuition, you end up buying high and
selling low, thereby undermining your
financial well being.
Behavioural finance
How Our Human Intuition
Undermines Our Financial Well Being
Money Compass 55 l December 2012
Money IllusionAssume now that you never took
your stockbroker’s advice to invest in
the shares of the large corporation
but instead left it in a fixed deposit
account. You justified to yourself that
you are not prepared to take the risk
of losing your hard earned RM10,000
(loss aversion). Furthermore, every
month when you renew your fixed
deposit you could see the money
growing by say 0.25%. Your money
would have grown by 3% at the end
of the one year. You feel satisfied to
see your money grow without any
hiccups.
Unfortunately, this is a money illusion
as you concentrated on the face
value of the money instead of actual
value of the money in terms of
purchasing power. In fact, if inflation
were growing at just 5% per year,
you would be losing your purchasing
power by 2% a year when keeping
your money in a fixed deposit
account.
Mitigating the Effects of Behavioral FinanceThe first step is to recognise the
existence of faulty intuition. The
second step is to think about the
possible pitfalls you may encounter in
your investment journey. The third
step is to have a robust process of
managing your finances. Having a
process is crucial because it sets out
the ground rules of how you should
behave when those pitfalls that could
trigger your faulty intuition appear.
Finally, engage the services of a
qualified financial adviser who has
lived and survived through market
cycles and is unfazed by market
volatility. He can help you craft that
investment process to ride out the
market cycles as your investment
eventually grows for your future
needs.
Behavioural finance