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Rumpelstiltskin Can't Be Your Plan

7 April 2021

In the tale of Rumpelstiltskin, a miller's daughter strikes a deal with a fairy-tale creature to create immense wealth; however, this comes at the cost of her future firstborn child.

When the imp comes to collect the debt he is owed, she manages to luck out and discover his name, Rumpelstiltskin, the only loophole through which she was able to void her contract.

But if she was not willing to sacrifice her child, why did she strike the bargain in the first place?

In the past, mainstream financial theory assumed in its models that people were rational actors, that they are free from emotion or the effects of culture and social relations. We all know this to be false. Humans are not perfectly rational but rather heavily influenceable — behavioural finance studies show psychological influences and biases affect financial behaviours.

So – why did the miller’s daughter strike such a deal? She was emotionally driven to create quick, easy wealth. Our stories may be slightly more complex, but we can improve how we make life and financial choices if we are aware of our biases.

A common theme among our biases is their subtlety in influencing our behaviour. For instance, when making an emotionally charged decision, we will often have reasoning that we believe to be grounded in logic. Only upon examining our biases and samples of such behaviours do we begin to see the flaws in our decision-making process.

Some examples of common biases are:

Confirmation bias

This is when people are more willing to accept information that supports their already-held beliefs. Let’s say information arises that endorses an investor’s views on an investment. They are more likely to allow this information to confirm their ideas – even if the information is flawed.

Experiential bias

Also known as recency bias or availability bias, this is when we vastly overestimate the likelihood of a recent event occurring again. For example, the 2008 financial crisis led many investors to exit the stock market, believing that such an event had a high chance of reoccurring. When, in reality, the market bounced back in the following years.

Loss aversion

Investors are reluctant to admit when they make a mistake. Loss aversion in the investment sense is trying to avoid mistakes by not ‘realising’ them. In other words, investors are far more likely to assign a higher priority to avoid losses than making investment gains. An investor only makes a loss on a stock once it is sold. If they hold on to the losers, they might still have a chance of bouncing back. This leads to the disposition effect where investors sell winners quickly to formalise their gains and hold on to losers for far too long, which appears to mitigate their losses.

Acknowledging our own biases and understanding how people deviate from rational expectations allow us to make more informed decisions regarding financial matters. We tend to listen to people in positions of wealth, thinking that they can provide us with the answers to our financial woes, but for all we know, they are where they are because of a gold-spinning imp (if it’s not our story… it may as well be a fairy tale).

SFP offers extensive financial services across multiple specialist fields. Our world-class financial services and advice expertise enable us to meet our clients’ individual needs and allow them to reach their financial goals.

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