The concept of investing to create wealth – or investing in someone else’s ingenuity – is a recent phenomenon when viewed through history’s eyes. In previous generations, wealth was mostly held by land owners. You either had it or you did not. Wealth was then passed on from one generation to another. The industrial revolution created the opportunity for hard work, creativity and entrepreneurship to create wealth. Another effective wealth creator was theft, as evidenced in the crusades! This new way of creating and building wealth brings with it many opportunities, but also a few pitfalls.
In South Africa, the first unit trust was launched in 1965. Since the art of accessible investment is only just over 50 years old, it’s no wonder that most of us cannot get our heads around it. Let alone then actually sticking to a long-term investment strategy when markets are all over the place.
As human beings we are hardwired to follow the herd to ensure our survival. For investments this instinct makes us continue to sell our shares when stocks are low and buy when they are high – which is the opposite to what we should be doing. Investors tend to use the most recent investment performance to extrapolate future performance and are fuelled by greed in a rising market, and fear in a falling market. Try as we might, we seem unable to act counter-intuitively when it comes to investments and wealth creation. Our hardwiring is difficult to overcome.
The answer to dealing with this wealth destroying behavior is behavioural finance. It is a relatively new field of study that is providing us with phenomenal insights on how we make decisions and act. Coming to grips with these learnings will have a huge impact on the future of investing worldwide. Sophisticated empirical studies are challenging the traditional view of decision-making in many areas ranging from asset pricing to savings behaviour.
Why should this new field of behavioural finance be of benefit to South Africans? The answer is simple: South Africans are, on average, under-saved, under-invested and under-insured.
After research for our book “How Much is Enough ?”, I diligently follow these eight simple and effective steps:
- Know what you spend
- Create a budget and stick to it
- Automate your financial transactions
- Get organised
- Check your credit card and banking fees
- Review your insurance terms and rates
- Pay annually if you can to exploit the time value of money
- Downsize where you can
We are living longer, and we have to shoulder an increasing responsibility for our financial well-being. Saving now is important, but it is important to remember to save for the future – and that’s where the reality of our financial behaviour becomes critical.
Use the available behavioural finance insights to create and sustain our wealth. With the right tools and advice, we can train ourselves to be watchful and avoid mistakes that will decrease our personal wealth.