You've probably dreamed of magically waking up one day to see that all of your personal or business accounts have ballooned to a bazillion-gajillion-ish dollars. But it usually doesn't work that way. (Or at least, it hasn't for me.) In-the-moment temptations, combined with increased costs, make it super hard to save and invest. It might get a whole lot easier to set money aside and protect it, though, thanks to investment companies that purposely are incorporating psychology to curb your impulses.
Financial companies now give people access to "robo-advisors"--that is, online investment platforms built on technologies that can provide automatic financial guidance to help you stick to a money plan. While some robo-advisors are simpler than others, the best can help with and personalize virtually every step of the investment process, including deciding what your goals should be, automating deposits and incorporating tax considerations. All you have to do is provide basic information, such your age and what you'd like to save for (e.g., retirement).
What inspired the psych-based, automated design
Dan Egan, Director of Behavioral Finance & Investments at Betterment, says that the biggest motivator behind the current robo-advisor trend was the financial crisis that hit a decade ago.
"Before 2008," Egan says, "much of the investment industry consisted of big financial institutions, which had little to no interest in giving consumers a fair shake. Some would even quietly encourage poor behavior through tactics like incessant emails, ads and website design. They were all designed to encourage rash, emotional reactions from consumers. They wanted people to think they had to trade now, to get a big win or avoid a big loss. They didn't care what that meant for the customer's portfolio, because the broker won either way."
But now, many investment platforms carefully are bringing psychology, science and automation together. As a simple example, Betterment, which bases its platform on work by the likes of Nobel Prize winner Richard Thaler and author Carl Richards, incorporates the effect of color. The team changed when they use red and green, for instance, because people react impulsively to those colors. The platform now color codes whether your plan is on track, too, rather than color coding historical returns. Egan further claims that Betterment also uses scientific trials to figure out how to communicate with customers in ways that reduce emotional decision making and market timing.
Changing your view by letting you step back
Because people can use robo-advisors to automate investment tasks, they go a long way in getting people into the long-term money mindset that's served Warren Buffet, Benjamin Graham John Bogle and many other money masters. You can set up what you want the platform to do and then basically leave it alone. By changing the habit of constantly peeking at what your accounts are doing, you're less tempted to make quick-twitch modifications, and it's easier to stay focused on your big picture. That can translate to bigger take-home growth for an individual or company--Egan asserts that investors cost themselves around 6 percent in returns each year by moving around in their investments, and that Betterment customers take home about 2.66 percent more in returns annually than investors examined in others studies.
A deficiency of forgiveness
"One drawback [to robo-advisors] is that we tend to be more trusting of humans, rather than computers," Egan says. "If a person has a 60% success rate, and a computer has a 90% rate, people still tend to trust the human more. When they see a computer make a mistake, they say 'you're done'. We're more forgiving of human error. We try to counter this by making our online advisor as human as possible. For example, we try to humanize our algorithms--basically asking human advisors questions, and turning it into an algorithm. We also show which advisors were involved in crafting the process being used."
How to boost your odds of a smooth investment journey
Regardless of whether you use a robo-advisor or go old-school, Egan says there are multiple steps you can take to proactively reduce investment mistakes for yourself or your company:
1. Keep a financial plan diary and map out you'll do if the market goes south. If you've got a plan, you don't have to resort to knee-jerk reactions.
2. Find someone who can give you a second opinion. Ideally, this will be someone who might have a different perspective than you.
3. Focus on facts about the future, not fear of the past. "[This isn't] always easy, given today's technology and news cycle. You have to tune out the noise and look at the reality of your money. And you should never act based on something you just saw on social media."
"We tell clients: If you're feeling emotional about your investments, you should log out and do something else," Egan concludes. "You'll end up making a better decision that you'll appreciate in the future.