As a practising financial planner, it is quite common for me to interact professionally with individuals having ‘self-control bias’.
Possessing traits of this kind of a bias is becoming extremely common nowadays. More and more individuals want instant gratification and hence are unable to make investments for the long term.
Even those who initially plan to invest for the long term, invariably end up breaking, redeeming or terminating their investments after a while.
Plethora of excuses
An older cousin of mine, who is now settled in our native place, would end up breaking his investments prematurely most of the time.
He would justify it on the pretext of some ‘unplanned expense’ either in the form of fees for his daughter’s education, or a wedding in the family, guests from overseas, or breakdown of white goods. And the list of reasons would go on and on.
Align goals, investments
The best option, of course, is to decide on financial goals and make investments aligned to them. Along with that, keep reviewing your financial goals and the investments linked to it, every three months, and make appropriate modifications. I keep encouraging this once-in-three months review with family participation with the coinage ‘financial date’.
It is extremely important to maintain a contingency fund for unforeseen expenses so that long-term investments would not have to be altered.
Another option is to break the investments in baskets. This could be in the form of two or three baskets, namely short-term, medium-term, and long-term. This will ensure that even when there is a genuine need, long-term investments are not disturbed.
To illustrate my point, I used to give the example of a train journey to my cousin, who is now settled in Ahmedabad. I would tell him “if you board a Duronto from Mumbai to Ahmedabad and suddenly decide to get down at Surat, there are two options — either jump off the train — which may cost you your life — or miss the station.”
Obviously, the example might have had only a temporary impact on him. The bias in mind is difficult to change as long as the individual is steadfast on it.
The primary reason this bias is present in all of us in some form or the other is twofold — firstly, while we all are aware of the fact that long-term investments yield much superior returns than near term investments. With the lure of higher returns, we all make investments for longer tenure. Secondly, there is an urge for instant gratification. To satisfy our urge, we terminate our long-term investments.
I have also come across several individuals who make long-term investments and to fulfil their immediate desires, borrow money. Since borrowings are now easily possible, this should be avoided. The rate of interest on borrowed funds is pre-decided and invariably fixed. On the other hand, returns on investment, usually long-term, are not certain.
Let us understand with two examples. Assume the investment is in an equity-based mutual fund. Returns from this kind of investment are subject to market risk and uncertain. On the other hand, if there is any outstanding loan, the rate of interest on this is certain. When both borrowing and investing happen simultaneously, there arises a situation where against uncertain returns there is the burden of a certain rate of interest.
In the case of fixed deposit or bonds or any other debt-based instrument, even if the scenario is different whereby the rate of interest on loan is less than the rate of interest on a debt instrument, if both have similar tenure, there can be a situation whereby upon maturity, the renewed investment may not yield similar returns.
The solution
While it is not possible to eliminate self-control bias, in order to reduce its impact, invest based on your financial goals. Do name it after the person whom it is meant for, for example daughter Laxmi’s higher education mutual fund.
This will act as a red signal in your mind when you feel the need to redeem money for upgrading your car or to go on an overseas trip. Always keep aside funds for emergency, and lastly go on a financial date every quarter. Biases do not go away because we are human beings and are prone to emotions, but with little effort its impact can be diluted.
(The writer is a financial planner & author of Yogic Wealth)