Why financial planning is not common sense

This Insight is for anyone who relies on common sense to guide their financial planning.

And, yes, that’s most of us, from time to time.

Here, we’ll see how common-sense thinking can lead us to make enormous mistakes with our money and in other aspects of our lives.

And we’ll offer some ideas for dealing with this.

Surely, it makes sense to use our common sense?

It’s certainly common to believe that common sense is a valuable and rare personal strength.

The French philosopher Voltaire bemoaned its scarcity in society when he said,

Common sense is not so common

Mathematician René Descartes seems to have shared that view when he joked that:

Common sense must be the most common commodity

because everyone is convinced they have it!

What’s fascinating is that the scarcity of common sense is attributed to us having too much information or education!

Writer, Gertrude Stein, said,

Everybody gets so much information – that they lose their common sense’

And Victor Hugo allegedly claimed that,

We have common sense despite of our education – not as a result of it.

However, not everyone is so enthused about the value of common sense.

Writer and Philosopher Henry Thoreau said,

There is no common sense. It is just common nonsense’

Albert Einstein described common sense as

The collection of prejudices we acquire by age eighteen.

And the psychologist and Nobel Laureate Daniel Kahneman is no fan of common sense either.

In his book, ‘Thinking Fast and Slow’, Kahneman describes common sense as being more about judging than thinking.

So, we might judge an idea to ‘feel’ or ‘sound’ about right, but that tells us nothing about its objective truth.

We’re just saying the idea aligns with our beliefs at that moment, and problems arise when we believe in flawed ideas.

In short, we’re not the best person to judge our own thinking!

Should we keep an open mind?

Science, Technology and Engineering – designed with advanced Mathematics, have delivered vastly improved health and living standards for billions across the world.

And much of our progress ‘stems’ from an idea that Socrates developed more than two thousand years ago.

The Socratic method of challenging each other in cooperative but argumentative dialogue is the basis of science today.

Progress has come from testing our beliefs – rather than trusting everything we’re told.

Common sense led us to believe that the Earth was at the centre of the universe. We could, after all, see the sun moving around us overhead.

It was also common sense to see that the Earth was flat back then.

And incredibly, even with pictures of Earth from space stations, some people still believe that!

More recently, a study found that up to a quarter of people in developed countries cite “common sense” for believing that climate change is not caused by human activity…

And another quarter cite “common sense” for believing it is!

If common sense is useless, why use it at all?

Well, let’s not throw the baby out with the bath water!

For simple and common questions – we only need common sense answers.

So, what Daniel Kahneman describes as our fast-thinking mode is perfect for answering the question of what is 2 x 2.

That question is easy because we can pull the answer from memory.

However, our slower, problem-solving mode of thinking takes more time when we ask the question of what is 16 x 23.

The answer to this question is not common sense at all.

And we can feel our brain strain as it switches from fast to slow-thinking mode  – to work this one out.

(The answer, if you don’t fancy doing that, is 368)

The story so far?

Common sense quickly fails us on even slightly difficult questions.

But we can answer those questions if we follow a solid process  – even if it’s just pushing the buttons on a calculator.

What if we don’t know a good process?

So, this is where we’re most likely to trip up, especially where we need to solve a logic puzzle or do some number crunching.

Try this puzzle – as an example:

A bat and a ball together cost £1.10.

The bat costs £1 more than the ball.

How much does the ball cost?

The question is simple – and the answer is common sense – right?

Or is it?

What answer did you get?

Try sending this post to a friend to see what answer they give.

And now, try this puzzle – it’s one of our favourites

Imagine a class of thirty children.

What is the chance that any two of them have the same birthday?

Don’t worry if you’re struggling to solve this one.

Everyone finds it hard unless they’re a ‘whizz’ at probability calculations.

And even the experts can’t work it out in their heads.

The truth is that most of us don’t know the process for solving complex problems like this. And even those who do need time to work out the answer.

What’s the answer to the ‘same birthday’ riddle?

Well, it will probably surprise you…

… because the chance of this happening is… 70 %!

In other words, in a group of 30 people, it’s very likely that at least two people have the same birthday.

How amazing is that?

Proving the same birthday probability

If the proof doesn’t interest you, skip to the next section

The incredible (70% chance) of having matching birthdays in a class of 30 children (or adults) is nothing like the ‘common-sense’ answer most people give.

Some say the answer is 1 in 12 (8.5%), which we assume is arrived at by taking the number 30 (of children in the class) and dividing it by 365 days of the year.

Others give estimates as low as 3% (1 in 30), which is also using the number of children, but without any more logic than that!

And if you’re reading this section, you want to know how to work this out.

So, here goes!

In short, there is absolutely no easy, common-sense way to work this out.

We might try to solve it by imagining the children in a row and asking what chance there is of the first child having the same birthday as the second, etc.

But this approach doesn’t reveal the chance that any child has the same birthday as any other.

To work this out, we must turn the question on its head.

By finding out the chance of our event not happening (which we’ll call ‘N’), we’ll know that the chances of it happening must be 100% minus N.

The chances of something not happening and the chances of it happening always add up to 100%.

Think about the chances of it raining plus the chances of it not raining tomorrow.

They add up to 100% because there are no other alternatives.

So we can solve the ‘same birthday’ problem by following the steps below, which are also shown in the table.

Step 1: Select any two children from the group to find the chance that they do not have the same birthday.

The chance of this is 364/365.

Step 2: Pick a third child (at random) to find the chance of this child not having the same birthday as either of the first two.

We assumed that the first two children had different birthdays, so those two have used up two birthdays, which means this new chance must be 363/365.

Step 3: Keep picking children from the class to find the chance that each one does not have the same birthday as any of those already chosen.

Continue this process until you reach child number 30.

Step 4: To find the chance of all these 30 children not having the same birthday, we multiply the chances of each step above.

This gives us the chance that the first two don’t have the same birthday and, the third child doesn’t have the same birthday as either of the first two and, the fourth doesn’t have the same birthday as any of the first three, and so on.

Step 5: To find the chance that any two (or more) children have the same birthday, we simply deduct the answer in Step 4 from 100%.

Here’s the table of the calculations.

Note you only need a group of 23 people to reach a 50:50 chance of two people in a group having the same birthday.

A fun riddle to ask your friends or colleagues at work?

Try asking your friends to call out their birthdays – one by one – the next time you’re out in a big group.

You’ll be amazed to see this work in practice.

Just remember, the chance of two or more matching birthdays is high – but it’s still only 70% for a group of 30 people.

So, you won’t get a match every time, and your friends might think you’re mad for asking them – if it fails.

After all, common sense tells us that there’s little chance of finding matching birthdays in such a small group of people, right?

What do these riddles tell us?

This is not about learning to work out the answers; interesting, though that is for some.

We offer these examples to show how our intuition and ‘gut feelings’ are useless for solving tricky problems.

The truth is, it’s difficult for us all (including those good at sums!) to shift into our ‘slow-thinking’ mode to solve problems.

Our brains are energy-saving devices. So, whenever possible, we skip the hard work and jump to (what we think are) the obvious answers.

And thank goodness our brains work this way.

Just imagine how exhausted we’d be if we had to stop and think about everything we did each day.

Remember your first day of driving lessons – or when you started learning a similarly complex task – like playing the piano or clarinet?

Imagine if everything you did all day long was as hard as those first lessons!

What about our bigger life challenges?

Unfortunately, our brains are so fond of this energy-saving trick that we too often use it on more complex questions – about life, love and money too.

So, we readily grab at simple common sense guidance to these challenges and say:

• Never look a gift horse in the mouth.
• Don’t cross your bridges before you reach them.
• Better safe than sorry.
• Money can’t buy you love !!!
• And so on…

And that’s all useful guidance which has stood the test of time.

Or, so you might think.

The problem is that for each of those common-sense maxims, you can find another which suggests the complete opposite.

So, for example:

• ‘Never look a gift horse in the mouth’ – is completely at odds with – ‘Beware Greeks bearing gifts.’
• ‘Don’t cross your bridges before you reach them’ – argues with – ‘If you fail to plan, you plan to fail.’
• ‘Better safe than sorry’ – suggests the opposite strategy to – ‘Nothing ventured, nothing gained.’

And finally, on:

‘Money can’t buy you, love.’

Well, this saying is at odds, both with the evidence and that other common sense saying that:

‘When money goes out the front door, love goes out the back’!

Here are some more examples:

The golden rule for complex problems

To be clear, shortcuts, rules of thumb and common sense answers can be helpful in some situations, some of the time.

We take shortcuts because our brains would be overwhelmed if we had to run a rational, multivariable analysis of every little decision we make.

Take choosing a basic product to buy online, for example.

We look at the number of 5-star ratings on the products we’re considering, right?

We know those reviews offer no guarantee of quality, but they’re often a useful guide on popular products. So, noting the crowd-view can save us a lot of product analysis time.

We just need to know when and on what questions to stop taking shortcuts.

We need to know when to stop ‘trusting our gut’ – another overused maxim.

George Bernard Shaw offers the golden rule for complex problems.

There are no golden rules.

Our lives are too complicated, sorry – unique to be ruled by simple answers.

So, we urge you to avoid common-sense guidance on the things that really matter in your life: your life goals for yourself and your loved ones.

Financial life planning is about what really matters

Sadly, there are now hundreds of thousands of unqualified but self-proclaimed gurus (‘Wannabe Finfluencers’) who wish to convince you that they have the answer to all your money worries.

And too many of them push a message that personal finance is simple.

We’re sure you’ve seen their posts and videos.

It sounds wonderful, doesn’t it?

But we know you know that there’s more to this than that!

Yes, we understand the attraction of simple ideas, but they don’t help us solve our complex and personal money challenges.

Let’s think about this.

How could there possibly be a single, common-sense solution to our unique (and very personal) set of financial life goals?

A single solution that takes account of our unique financial circumstances and attitude to money?

No, that’s just nonsense – your financial plan must be tailored to your personal needs.

So, no TikTok or YouTube videos (and no book or article in the money pages) can give you a personal financial plan.

However, a financial planner can help you design a plan – to achieve more of your particular (financial) life goals.

And they can help you make more of your money – without taking crazy risks – by reducing the drag of unnecessary taxes, excessive product charges or poor returns on your money.

A good Financial Planner will explain your financial options in plain English, of course, but they won’t pretend it’s all simple if it’s not. So, to that extent, they’re aligned with another idea from Einstein.

The bottom lines

We need proven processes to solve complex problems – if we’re to avoid the chaos of common sense answers.

Whatever any ‘guru’ (or anyone else) tells you, the truth is that managing all aspects of your money may not (always) be simple.

Researchers in financial literacy are clear that money management can be complex at times.

It can also be a challenge to keep our income above our expenditure while paying down a mortgage and other debts on which interest charges can vary – a lot.

On top of that, we need to build funds in accessible savings accounts to cover emergencies – and save and invest for our medium and longer-term life goals.

And most of us will face many other money challenges through life, too, as shown here – though thankfully, we won’t face all of these money challenges at once!

It’s essential to note also that there’s no common-sense way to work out our numbers on our longer-term goals.

So, we need a sensible process to work out how much to save – and must think about:

• What we’d like to have (and what we’ll need) in today’s money terms for our various life and retirement goals.
• When we’d ideally like to have achieved those goals – and any flexibility we have on those target dates.
• The best financial products (and funds) to help us achieve those goals – taking account of tax and various other factors.
• The assumptions in our plan:
  • On how inflation will affect the cost of our goals over time.
  • On the returns we might reasonably expect from our savings and investments.

Now, you’d think that all of this is enough to think about…

However, we may also need to consider how our behavioural biases might prevent us from achieving our financial goals.

Behavioural biases (like relying on common sense thinking!) are natural human behaviours that we’ve evolved over thousands of years.

But they don’t all serve us well in the modern world, and many of these biases can undermine good decisions. So, we’ll talk more about these in the future.

Education is key to your financial success.

What can we say about financial education in the UK?

In short, some schools teach a few lessons on short-term money management, but the picture is variable across the country.

And that’s a problem, but it’s compounded by the fact that long-term financial planning isn’t taught at school at all.

Financial Planning isn’t even taught in Business or Economics degree courses.

So, most people need to learn more about this.

And the good news is that more knowledge can lead to more engagement with (and enjoyment of) the financial planning process.

What will you take away from this?

We hope you found this Insight useful. And, if you needed any persuasion, it’s encouraged you to learn more about financial planning.

We’d love to know about the key points you’re taking away from this – and if you’re happy to share any thoughts in the comments, or by e-mail, we’d love to hear from you.

We’re here for you on this journey. And, as you’ll have guessed by now, we don’t believe there are many useful common sense maxims when it comes to your financial planning.

That said, we do have a simple description of what good financial plans deliver – when they’re acted upon. And it’s this:

A good financial plan puts the right amount of money in the right hands at the right time.

And, for the most part, those hands will be yours in the future.

So, you’ll have the money you need to pay for what matters to you – your goals for yourself and your loved ones.

Thanks for dropping in

Paul 

For Financial Advisers, Planners and Coaches

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