How Qualitative Factors Impact Financial Planning

March 14, 2024

Warren Buffet once wisely observed: “The most important quality for an investor is temperament, not intellect.”

Buffet’s astute understanding of the subjective forces that define the investment process reveals a deeper grasp of the underlying psychology of investing and managing wealth. Investing is fundamentally predicated upon quantitative, objective facts – like stock prices, rates of return, bond yields, and interest rates  – yet it's influenced by a number of qualitative factors.

There are many examples in the investment field today which illustrate this point. So called “ESG” strategies, which incorporate Environmental, Social, or Governance factors in the security selection process, are one such example. What one investor may find to be an admirable “Social” policy of a given company, another may find objectionable. ESG strategies can also have significant differences in the criteria considered when deeming whether a company has positive or negative ESG traits. As a result, ESG investment products can vary widely from one another based on the subjective nature of the process. 

Personal financial decisions are also impacted by subjective factors, and thus financial planning and investing often operate at the intersection of the quantitative and the qualitative. The way each investor thinks about money is unique because he or she has been shaped over time by a distinct blend of factors, influences, and experiences. Factors that can influence an investor’s perspective on financial decisions include family and cultural background, risk tolerance, personal values, and family dynamics.

For example, if you grew up in a family of limited means, you may have a more conservative approach to building wealth. Or, if you’re 55 years-old and in a second marriage with young children, your priorities will likely be markedly different compared to a friend who is the exact same age, but in a first marriage with adult children.

It’s important to consider these subjective factors when crafting a financial plan and investment strategy. Ask yourself what you value most when it comes to money and what’s important to you. Financial planning involves more than just assets, liabilities, and cash flows. The human element is critical when it comes to investing and planning.

Behavioral Finance

Traditional finance is predicated upon the assumption that the market and investors operate rationally and are not subject to cognitive errors. The field of behavioral finance blends economics and psychology, examining investor psychology as it relates to a variety of financial decisions. Behavioral finance is founded on the belief that investors are, in fact, perpetually influenced by their own cognitive and emotional biases.

In the 1970s and 1980s, psychologists Daniel Kahneman and Amos Tversky joined forces with economist Robert J. Shiller to conduct several studies about how the financial markets can be affected by the emotions, viewpoints, and subjective experiences of investors. This approach countered the long-held assumption that investors – and financial markets – are always strictly rational and predictable.

Over the years, numerous studies have identified several key factors that affect investor psychology, including education, demographics, income level, investment knowledge, level of optimism, financial literacy, peer exposure, and financial self-efficacy. A 2020 study published in Frontiers in Psychology found that investors’ attitudes toward money shape their investment decisions, including their willingness to assume risk by investing in the stock market.

Likewise, a 2023 article in Cogent Economics and Finance examined the impact of behavioral finance factors on investment decisions, concluding that “individuals’ cognitive biases and emotional responses can influence their investment decisions. Risk perception, in this context, serves as a crucial intermediary variable that helps explain how individuals perceive and interpret risks, which subsequently affects their investment decisions.”

A Deeper Understanding of Wealth

An important first step in promoting long-term success is to develop a deep understanding of what is most important to the family. For some, it may be as simple as structuring financial resources to enable a life well-lived with the least amount of financial risk possible. For others, legacy goals may be an important consideration. For most, it’s a process of balancing a complex combination of goals and priorities.

Estate planning is a good example of a planning discipline which incorporates both quantitative and qualitative factors. Some decisions may be focused on reducing taxes, but others -- like putting the right protections in place for a trust beneficiary or the selection of a Trustee -- may be more focused on promoting family harmony. Whatever the right technical strategy may be, having a strong understanding of the top priorities of the family helps provide a solid foundation to guide the decision-making process.

However, developing a good understanding of family priorities and motivations can sometimes be easier said than done. For some, it can be as simple as a conversation among spouses about family dynamics, health concerns, or important life lessons learned from a parent. In other cases, it can be more complicated. For example, a family business, shared family home, or treasured family heirloom can create additional complexity.

Naturally, it can be complicated too for a larger group of family members spanning multiple generations to make decisions about emotionally charged family issues.

For assistance with some of these more complicated scenarios, a growing number of “family governance” professionals work solely with families to promote better relationships across generations and to help families devise strategies to preserve and pass on shared core values. This type of family governance exercise is intended to establish or articulate family values or priorities that can help inform legacy and estate planning as well as other aspects of financial planning.

Although not all families have a desire or need to engage in comprehensive family governance planning, it is helpful for investors to take stock of their own priorities. Keeping these guiding principles top-of-mind when working through challenging planning considerations helps to ensure that your decision-making reflects what matters most to you.

Blending Quantitative and Qualitative Approaches

As fiduciaries, we recognize that each family may have different priorities and concerns and that an investment strategy and financial plan should reflect that. Considering subjective factors when managing investments or making financial decisions leads to greater confidence in your plan and, ultimately, to better long-term outcomes.

We are here to help guide you and your family as you plan for the future. If we can be helpful to you in this regard, we encourage you to please reach out to us for guidance.