The law of the Instrument is a cognitive bias that involves an over-reliance on a familiar tool.
“I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail” ~ unknown
The illusory truth effect is the tendency to believe information to be correct after repeated exposure; i.e. believing something to be true because you repetitiously hear the same thing over and over.
Attributed to sources ranging from Buddha and Mark Twain to the Bible, the origin of the above quote is questionable. While it’s been stated differently throughout history, the world of psychology attributes The Law of the Instrument to psychologists Abraham Kaplan and Abraham Maslow (Maslow being best known for Maslow’s hierarchy of needs).
So what does this have to do with investing and income planning?
Our experience suggests that a large percentage of investors allows both the law of the instrument, (a cognitive bias that involves an over-reliance on a familiar tool) which they’ve learned large in part to the illusory truth effect (a tendency to believe information to be correct after hearing the same thing over and over), to influence their investment decisions at a time when making the right decision is never more critical.
In understanding that each investor’s situation is unique, allowing the influences and biases of those who are more than likely in a vastly different financial situation than your own, can adversely impact the retirement you desire. If you are extremely risk adverse and hope to live your retirement years as such, asking the advice of a friend and advisor who has a propensity to gamble, might not be a good idea?
When the time comes for you to leave your primary source of income, the number one thing all investors now need, is a new and predictable, primary source of income. Where is that predictable income stream going to come from? Will it be Social Security or an outside savings account? Do you plan on accessing a steady income stream via your 401k, 403b or other individual retirement plans, or possibly a combination of the aforementioned?
Studies clearly show, year in and out, that outliving your money is the number one fear of soon to be retirees. In a study done by insurance behemoth, Allianz, 92% of respondents believe “somewhat or absolutely”, that the United States is facing a retirement crisis, with 47% fearing not being able to cover basic living expenses in retirement. Interestingly enough, this is also the number one fear of their financial planners as well. These numbers are staggering and it shows the financial industry is failing miserably.
So what can you do about it?
We firmly believe that understanding these cognitive biases exist and may have a large impact on your decision making is paramount to breaking the societal norm. Simply recognizing your belief system may have been formed having been surrounded by a narrative that may benefit a particular industry vs. you is half the battle. We need to remember why 401k plans were implemented and what they replaced? (remember pensions?)
Recognizing the above is a start, though we also attempt to utilize a different approach. As noted in our philosophy section, Shoshin is a term used by Zen Buddists to describe an attitude of openness, eagerness and lack of preconception when studying a subject, even when studying at an advanced level. Just as a beginner would, this is also known as “beginners mind”.
We approach the subject of income planning in this manner. What instrument(s) will provide you with the most predictable and reliable source of income for the rest of your life? Your retirement income requires predictability and prudence, not hope. We would advise against allowing someone else’s Law of the Instrument dictate what the right instrument is for you.
In its most simplistic form, our views attempt to take as much “guess work” out of the equation.
We believe there is a mathematically correct solution for each of us based upon our own individual wants and needs. Our definition of a “mathematically correct solution” is one, which provides a predictable replacement income stream for life that has the ability to increase over time with inflation; one that addresses immediate emergency needs, while also providing growth throughout your retirement years. A properly designed, well-executed plan implementing the best of breed solutions from each segment of the financial industry takes the pressure off any single one to perform.
Our top priority is addressing your every want and need with predictability and safety, utilizing the proper tool for the right job within the plan where the tools characteristics dictate its use, NOT a cognitive bias.
Those looking to draw income from investments exposed to market fluctuations are subjected to sequencing of returns. We would advise against using hope or luck as strategies of choice when predictability and prudence is necessary, as is the case when it comes to retirement. Finally, we would advise against allowing someone else’s Law of the Instrument to dictate what the investment instrument is for you.