Intuitively, most people establish financial plans and then work towards executing them. However, the circumstances may have already changed by the time you get to take action. Static plans seldom account for shifting circumstances.
Informed decisions are always made when feedback loops are integrated into the process. Be it a gold investment company, stock trading, or just sorting out your household finances, you always have to adapt your plan to reality and not attempt to squeeze reality into your plan.
Feedback loops in financial planning are useful for both large corporations and private individuals and provide benefits such as risk mitigation. The main point of this article is to outline some feedback loops in theory and then look at how they can be implemented in your plan.
What are feedback loops?
A feedback loop is a self-feeding mechanism. As the process goes on, data is generated along the way. That data can either be used to look at what worked and what didn’t, or it can be discarded in favor of looking at the results. The latter approach is sub-optimal.
We can have two main feedback loops:
- The positive feedback loops seek to hasten either decline or growth. For example, a well-planned investment portfolio will almost belt-feed the revenue from earnings back into the portfolio itself, leading to even more earnings and compound growth.
- Negative feedback loops are mostly set to correct negative deviations. As an example, if the amount of costs outstrips the revenue, then the person or the company needs to account for that and reduce costs in the following months to balance the overall margin and adhere to the budget.
Be it negative or positive feedback loops, decision-making in finance needs to integrate them. Either as a catalyst for current financial trends or to compensate for a loss that threatens under-recovery.
Other benefits of implementing financial feedback loops.
Feedback loops can improve financial results, as previously mentioned. However, this is often not achieved directly but as a consequence of letting the user have better decision-making.
“Firefighting”, or chasing after problems after they happen, is guaranteed to fail, as you are not being proactive. You are waiting until it is way too late to mitigate damage. Meanwhile, business feedback systems feed you with the info needed to see early warning signs and adjust accordingly, ahead of time.
More financial awareness
Feedback loops allow the user to constantly see and analyze savings, income, expenses, and investments. It is almost impossible for all of this knowledge not to aid the user in improving his status. The control will be finer, with tweaks instead of massive shifts and actions that are often too low-resolution to be effective.
Budgets that better reflect reality
Traditional methods of budgeting can be too rigid. They are set at the beginning of a financial semester, quarter, month, or week, and in theory, the person or company cannot overspend. In practice, life is complicated, and things you didn’t plan for can occur.
As a result, unexpected expenses can ruin your budget. Let’s say that your car breaks down, or, in the context of a company, some servers need to be bought and replaced. Regardless of what an emergency expense may look like, it will offset your budget. Feedback loops permit real-time tracking, and you can make adjustments on the fly. By analyzing this data, it can be very hard to overspend and live beyond your means.
Investment
Similar to our previous point, the same benefits can be seen when investing. You are able to make portfolio changes in real time and be much more responsive to changing circumstances. Information such as risk factors, weighted values, market trends, and previous financial performance can be considered. All of this data empowers more refined strategies that maximize returns on investment while keeping risk at a minimum.
Less impulsivity
Most people do not plan their finances to maximize returns and efficiency. Most purchases happen on impulse, for emotional reasons. In fact, marketing aims to stimulate your emotions as much as possible, because they know that if they get you to think with that side of your brain, you will be less rational.
However, over time, trickles turn into rainstorms, and impulse transactions can add up to a lot. Real-time feedback for financial decisions can be a reminder that you need to think with your head and prioritize long-term financial stability, instead of satisfying a soothing whim.
Waiting times are cut
The role of feedback in corporate finance provides similar benefits to that of personal transactions and budgeting. A private individual has much more control over his options and decisions. He can check his budget 5 times a day, shift expenses whenever he wants, etc. Meanwhile, a corporation often functions as a miniature country, with various departments, jurisdictions, dependents, and risks. And such a large beast is often hard to steer. Especially if you aren’t working in the finance department, you often worry about finances in quarterly and semester increments.
Feedback loops can serve as gentle nudges and reminders that any decisions made need to be contrasted with the overall budget. Of course, this applies double for those who are specifically oriented towards finance. Continuous feedback for financial professionals is not an optional perk. It is a necessity, and you’re not doing your job well if you’re not looking at the data.
Retirement plan
Let’s entertain a thought exercise. Think about the year 2018, and let’s say you were attempting to make financial plans then. Could you have ever accounted for all of the crazy events, such as wars, global inflations, blocked trade routes, lack of resources, and so on? And all of this happened in less than 10 years.
Imagine what other events can happen until your retirement. This is the reason why long-term plans, unaided by feedback loops, will always fail to account for every change. Feedback improves financial decision-making in an ever-changing world. Sometimes the benefits will be hard to measure, but by the time you reach retirement, they will be obvious.
Conclusion
There are two types of people in the world: those who make things happen and those who wait for things to happen to them.
The current financial landscape has never been so dynamic and volatile, as boundaries are redrawn, and dominant industries are having their bubbles burst. As a result, everything that happens is a piece of data that tells you something about the world. That info needs to be used and fed back into the system to allow you to budget better and make smarter financial decisions.
