Yet in the early 1970s and 1980s inflation was even higher, so the interest rates and many investments were reducing rather than increasing the investors' future spending power. Still the headline number was big enough to hide the costs and charges and satisfy the clients.
Today information is more freely available, and our industry is so much more transparent; the client can not miss the charges nor the performance - even if they do, it is sent to them to make sure, and they are getting a much better deal.
It just does not feel like that when you look at lower or negative returns, or worse, a small positive return that becomes negative because of the cost of advice.
This problem is known as the ‘Money Illusion’, a phrase first coined by Irving Fisher in his 1928 book and used by both Keynes and Freidman.
Setting aside both suppliers and governments who contribute to the illusion through a reluctance to change prices and report uncomfortable numbers there are three human factors that we can seek to manage: -
Myopic loss aversion
If we keep checking headline performance, or having it pushed onto us we can lose sight of the big picture. The perceived immediate loss in the numbers feels more real than the impact of inflation that feels more long term and indirect. For example:
- If inflation is 14 per cent and returns are 12 per cent, this is a real loss of 2 per cent
- If inflation is 0 per cent and returns are -2 per cent, this is a real loss of 2 per cent
Despite giving the same outcome, behavioural psychological research suggests that people feel 1) is better than 2)
Heuristics or rough rules of thumb
People do not - or don’t like to - make precise calculations. Big round numbers seem good, small precise numbers can get rounded to feel worse. People remember a round number they invested, say £100,000 but do not think about the small gradual fall in its purchasing power.
Missing information
People can easily see their money in the bank or salary, but real value or real wage requires knowledge of price changes and calculations.
So how do we overcome this?
