Neuro-finance

A widely accepted fact of financial planning, as a profession, is that it is two-thirds moral and ethical skills; from fields such as psychology, sociology, and philosophy; and one-third technical and analytical skills; stemming from finance, economics, and mathematics. If this is true for financial planning professionals, shouldn’t it be equally true for each of us as we work through our financial lives?

On Monday, I was again privileged to hear Douglas Lennick, CFP® address the Annual Meeting of the Financial Planners’ Association in Boston, MA. I believe his insights into how our cognitive, neurological, and emotional “parts” work together is very relevant to our decisions stemming from the current financial malaise (i.e., mess!). First, he asked us to draw the diagram to the right on our notepads. Then, he indicated that every time we are stimulated to act; the cognitive, neurological, and emotional facets of our mind work together to decide on our reaction to the stimulus. If we do not like our actions in response to certain stimuli, we must consciously try to change the paths our decisions take between and among the three spheres. (He used the analogy of the mind being a large grassy field, where trails have been worn by our repeated reactions to stimuli. If we consciously try to use a new path, eventually a new trail will be present, while grass grows over our old behavioral pathways.)

Then, he said the punchline, “ Everytime we receive a new stimulus, we first react emotionally” which, at times, can be quite distant from cognitive, rational thought. Certainly, the current stimulus of the credit collapse has had its share of emotional reactions. The question is, What do we do next? He gave us two rules and four skills to practice. First the rules, then the skills.

Rule #1: Always be prepared for the certainty of uncertainty.

Rule #2: Always make financial decisions based on personal values.

If you want to change your responses to stimuli, you must be guided by your personal values. He encouraged us to work with our “clients” to help them create new pathways in their response to stimuli.

To begin, one must recognize one’s own experiences of the relationship between one’s emotions and cognitive thought. Do you see the current situation as a threat or an opportunity? Are you running from it, sticking your head in the sand, or embracing it and trying to learn from the situation? What is your emotional response?

Second, reflect on the degree you are meeting your responsibility to prepare for periods of uncertainty. Reflect on the big picture. Consider your goals, your current financial plan, your portfolio’s diversification, your insurance coverages, your family, and get yourself ready for the long-term. Is your plan consistent with the values and the principles you wish to display to others?

Third, reframe your self-talk to look for possible biases that might exist. Ask youself if you’re being too emotional in your response and strive to create a construct for your future decisions that can exist without these biases.

Finally, respond with a decision that is consistent with your moral principles and implement a plan that is consistent in supporting your goals.

The best place to start revising your emotional, cognitive, and neurological makeup is to decide on the rules that will guide your journey. Have you listed your primary values? Have you written them down? Do you reflect on them daily? Take a moment and list your primary values and periodically ask yourself if you’re making decisions that are consistent with those values. Mr. Lennick listed his: family, happiness, wisdom, integrity, service, and health.

If our fellow citizens on Wall Street and in the mortgage security business would have done this exercise and lived by it, my guess is that the decisions rocking the world may never have been made. Think about it. If a lack of principles and values can create financial distress for millions, couldn’t it be the case that an abundance of principles and values has the possiblility to create Financial Success for one?

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

Dollar Cost Averaging – A Primer

Learning how to invest often seems like a daunting and frightening process, and all too frequently financial professionals use a language of their own to potentially confuse, rather than educate, their clients. Many financial professionals feel their livelihood may be threatened if the larger society understands the principles to building wealth. Other advisors might fear that their client will not find value in the relationship, if the investment professional is telling the client what the client already knows. Such beliefs have been a bane to individual investors and the industry as a whole for decades, but there is a way to combat the confusion that comes with being in unfamiliar territory. It is simple. You learn the language. For example, understanding the concept of dollar-cost averaging is one of many strategies that can help you make sense of investment advice and judge the quality of the recommendations received.

As most people know, investment markets tend to trend higher over extended periods of time. Many forget that picking the tops and bottoms is everything but it is impossible - even for the most seasoned of market timers. Let us say that again, Market timing is everything but it is not possible. Moreover, we may enter periods where investments decline for years at a time. While most know these facts, the fear associated with potential declines keeps many people from ever entering the realm of investing. There is, however, a solution and many of us use it each time we make a deposit to our 401k or 403b retirement plan.
Whether you call it that or not, dollar cost averaging is an investment discipline in which investors commit a specific amount of money to their portfolios at designated intervals, say monthly. This helps to mitigate volatility and ensures that investors purchase more of the underlying securities when the price is low, and less of the security when the price is high. Buying low and selling high is the key to investment success and this strategy helps take care of the buying half. Moreover, once you start, you don’t have to think about it other than to rebalance to keep your investments diversified.

As an example, let’s say you invest $50/month into a mutual fund. If the fund is trading at $50 a share in the first month, you will buy 1 share of the fund. If the share price takes a precipitous decline the second month and is now trading at $25/share, the same $50 will purchase 2 shares the second month. You now own 3 shares at an average price of $33.33/share and you have bought twice as many shares at $25 as you did at $50. In other words, you are ensuring the purchase of more shares at lower prices.

Let’s say in the third month the price is again $50. Had you put $150, as a lump-sum, in the market the first month and not dollar-cost averaged, you would have purchased 3 shares and they would be worth what you paid for them, $50, a 0% return. On the other hand, had you dollar cost averaged at $50 per month for the three months, you would own 4 shares, worth $200 for a 33% return on your invested assets or $150. You see, as long as a lower price exists prior to the final price, you will have more shares purchased at the lower price to enhance your return. There you have it, Financial Success in a nutshell called Dollar Cost Averaging.

Heath Lauseng[i] and
Robert O. Weagley, Ph.D. CFP®
Chair, Personal Financial Planning
University of Missouri
Columbia, MO 65211