Wednesday, May 11, 2016
Cognitive and Behavioral Approaches in Financial Planning
Different financial theories such as Capital Asset Pricing Theory, Modern Portfolio Theory, Economic Theory,etc. that provides guidelines for investment do not able to predict the exact behavior of an individual in the real scenario. Individuals behave differently than the one predicted one by these theories. These theories missed the practicality of the situations.Individual personality traits and emotional issues are not dealt with these theories. Financial planners analyze the client’s existing and upcoming financial situations and manage the money through the strategic investment decisions so as to fulfill the client’s short term and long term goals. For this, they need to know clearly the expectations of the clients as well as their assets and liabilities. In handling all this process, they have to work very closely with the clients so that they can understand the clients and can act accordingly. These all help the financial planners to do the effective planning to achieve the client’s goals with efficiency. Financial planners are now realizing that there are other factors such as personality traits, cognitive and emotional parameters, apart from financial issues, can have an impact on the financing and investing decisions. By being aware of the psychological factors, financial planners can identify the behaviors of their clients which can influence the process in achieving the client’s long term goals. . So, it became imperative to include the Psychology based theories in the financial planning process. For this purpose, cognitive and behavioral approaches are included in financial planning.
Let’s have a look how the cognitive theoretical approaches have been incorporated in financial planning.
In any type of financial planning, dealing with the risk factor is an important aspect. Financial planners should have a clear idea of each client’s risk tolerance level. For example, a client is financially struggling to meet its day to day life expenses. In this situation, he can’t handle the additional risk. Financial planner should be aware of this type of situation. Based on this, they can take the investment decisions. Ultimately, financial planners are doing work for clients. So it is essential to know about how much risk the client can tolerate before making any portfolio or investing in any asset class. It is only possible if the financial planners discuss the past experience and risk taking a history of clients. Through this, financial planners can identify the client’s risk tolerance level. They can predict the client’s behaviors in an adverse situation, if any. All these help the financial planners to set the risk component level in their strategic investment decisions and to handle the risk factors as per the client’s psychology.
By realizing and understanding the behavioral issues, the financial planners help their clients to make better judgments. For example, people are more likely to invest in local securities to which they are aware of. And they want to have these securities only in their portfolios. This way, they may not have the optimum portfolio. Here, perception of the investor influence the investment decision. In such a case, the financial planner has to talk with clients explaining about the diversification strategy where higher expected return can be earned at the lowest risk level.
Financial planners by themselves should not be biased in making investment decisions. For example, some financial planners have the perception that female investors are a less risk taker. But it is not the fact. As a result, there will be mistakes in financial planning and it won’t be effective.
According to a cognitive theoretical approach, human behavior is highly influenced by their perceptions, attitudes and expectations. Financial planners need the client’s approval to implement their action plan. If clients are not convinced with the financial planners’ strategic investment decisions, nothing will happen, no matter how effective the financial planning is for a client. Sometimes, for the client’s best interest, financial planners have to influence the client’s emotions. For this, they use logic, facts and past experience of similar situations. This way, financial planners can change the client’s perception and emotions so as they react in the desired manner.
Financial planners should control their emotions. They should make the investment decision during a calm time as suggested by financial management assignment help experts.
Here, we have realized how important the cognitive and behavioral approaches in financial planning. For example, identifying and understanding the client’s risk tolerance level is one of the essential factors of the investment decision making process. Without the idea of the client’s risk perception and risk tolerance, financial planners can make no investment decisions. Apart from that, we have realized in the above part that there are many other scenarios where behavioral aspects can have the impact and influence in investment decisions. For this, the cognitive and behavioral theoretical approaches guide the financial planners and without it, no effective financial planning is possible.And in case you are finding all this too overwhelming there are always assignment help experts to help you out.