Why the Best Financial Decisions Often Require a Longer Time Horizon

Why the Best Financial Decisions Often Require a Longer Time Horizon

The majority of financial errors aren't the result of poor mathematics; instead, they arise because the wrong time frame is being considered. For example, people might cancel a policy in order to save money this month, choose the cheapest type of coverage rather than one that suits their needs, or construct a retirement plan based on an 'average' lifestyle which might have little or nothing in common with their own. Decisions that seem reasonable when looked at over a period of 12 months can appear very different when viewed over 30 years.

We sought out three experts  in longevity finance, in life insurance, and in behavioral health to find out why extending the time horizon alters the answer and to discover what obstacles there are.

Your plan is probably built for someone who doesn't exist

The variable that is most important over the long term is in fact the one that is most ignored by people who draw up plans: the length of your actual lifespan.

"Every portfolio today is built for an average person who does not exist," says Jay Jackson, Chairman and CEO of Abacus Global Management. "Retirement drawdown, estate planning, how much risk to carry: all of it depends on lifespan, but most plans regard it as a general assumption rather than as a personal one. In the case where you plan for 85 and actually live to 97, your retirement situation is quite different.On the other hand, if you plan for 97 but your actual lifespan is shorter, you might end up not making the most of the years you do have."

Jackson claims that it is now possible to quantify lifespan at the individual level. "Over the course of more than twenty years we have gathered proprietary data on mortality and medical records, stuff which has been verified in accordance with the Gompertz law of mortality. It is because of this that we are able to convert a person's expected lifespan into a personalized figure that a planner can genuinely use, rather than an average taken from a table."

He also points out that extending the horizon affects the way people assess the value of the assets they already own. "Most elderly policyholders believe that a life insurance policy has only two possible outcomes: to continue paying up or to allow it to lapse. There is, in fact, a third choice. Before deciding to surrender or let the policy lapse, it is important to find out what the policy is actually worth on the secondary market. This is a decision which people frequently make swiftly, under short-term pressure, since the amount involved can be substantial."

Protection decisions are 20- and 30-year decisions

Life insurance is a clear example of a situation in which short-term thinking leads to problems for families; the usual tendency is to go for the lowest monthly premium or to delay making the decision until life has settled down.

"Life insurance is the only type of product which replaces your income and ensures that families remain in their homes and within their communities," says Jeremy Hewett, President and CEO of Life insurance agency AccuQuote. "Therefore the appropriate question isn't 'what is the cheapest policy available today?' but rather 'what would my family actually need over the next 20 or 30 years if my income ceased?'"

Hewett states that this involves considering the entire horizon rather than choosing a round figure. "Begin by working out how many years' income your family would need to replace. Then add the remaining balance on the mortgage, the future costs for your children such as college, any existing debts, and your final expenses. The result is very different for a young family with a new mortgage from what most people would guess simply by thinking about it." 

He most frequently notices the mismatch when it comes to the term length. "People select a term which ends before their mortgage has been paid off or before their youngest child moves out of the house. The policy seemed satisfactory on the day they purchased it, but it was not designed to last for the years that are most important. The role of a licensed agent is to go through that timeline with you, not merely to give you a quote."

Why our brains default to the short term

If the ability to think over the long term leads to better results, why is it so difficult to do? One reason is psychological in origin: financial pressure causes a person's attention to focus only on what seems urgent at the present moment.

"When people are under financial stress, many find their thinking shifts toward immediate relief: whatever makes the pressure stop today," says Sarah Couture, Clinical Director at Rubicon Mental Health . "That's a very human response. Stress makes it harder to weigh future consequences, so decisions that trade long-term stability for short-term relief can feel completely reasonable in the moment."

Couture states that the first thing you should do is realize that a decision is being influenced by that kind of pressure. "In our clinical work we place a great deal of emphasis on emotional regulation, which involves developing the capacity to notice a strong emotion, pause and then respond rather than react; the same applies to money. If a financial decision seems urgent and you realize that anxiety is causing it, that is a sign that you should slow down, not speed up."

She says that it is better to rely on a practical approach than on sheer willpower. "It often helps if people set a waiting period before making any important financial decision, discuss it with someone they can trust, and write down how they would like their situation to be five or ten years from now. When the long-term goal is put down in writing it becomes easier to compare it with the things that seem urgent at the moment."

Couture also points out that when financial worries have an effect on your sleep, on your work, or on your relationships, it is important to take them seriously. "There is a close link between financial stress and mental health; if concern about money is interfering with your daily life then it is helpful to consult a qualified mental health professional. Seeking support is an indication of good planning, not a sign of weakness."

Change the question to get a better answer

In the fields of finance, insurance, and psychology experts point out the same thing: when making a financial decision you should consider how it will appear over the entire period it affects.

It involves basing your plans on your own probable lifetime rather than using the average figure, ensuring that your insurance covers the years during which your family relies on you, and being aware of the situation where short-term stress is causing you to make a decision. The best financial decisions seldom seem urgent and usually only appear obvious when looking back on them, which is precisely the reason it's important to make them deliberately.