For years I’ve been intrigued by how client’s financial decisions are very closely linked to their emotions about money. This is one reason why we take so much time at Herbert Scott to understand these feelings; we believe it’s a critical step in delivering great financial plans that you can stick with long-term.
Part of our process involves getting to understand clients’ fear of losses. It almost goes without saying that the difficult times we are currently facing are providing a fascinating insight into the behavioural science of investing. It’s relatively easy to try and calm fears about the stock market falls by putting these into context using charts of previous events we have experienced, such as the credit crunch or the financial crisis. But to most investors, this time things are different, as we are also faced with an over-riding concern about the health of our families, our friends, our neighbours, and ourselves. This really is a different type of emergency we are facing, which has the ability of heightening investors emotions towards their portfolios.
As financial planners, our role is to help clients hold their nerve. We try to explain to our clients what the rational decision processes should be. What we should also be doing, however, is to think about what real people actually see and do in times like this and be understanding and supportive of this.
The following two charts provide a fascinating insight into how easy it is for us to trick our brains into thinking something is what it isn’t, and that’s without adding into the decision-making process the stress of facing a global pandemic.
Rational minds can act irrationally
© Morningstar. All Rights Reserved.
According to a recent Morningstar webcast, human instinct when investors are faced with such adversity is to react in one of the following ways: –
Fight – The fighter tends to come across as being overconfident in their decision making. They think they know better and surround themselves with data, news and facts that re-enforce their own thoughts, whilst disregarding the possibility of there ever being a second side to the coin being tossed into the air. As your financial planner I listen out for the language being used, such as the phrase “I am certain” and challenge this in a compassionate and understanding way. Investing is after all different to speculating, it involves having a long-term strategy and not trying to outguess markets.
Fright – For clients that are anxious, loss aversion is priority, where the pain of loss far outweighs any pleasure of the gains. Frightened investors are hypersensitive to losses and for these clients our role is to try and help you to adjust your psychology and shift the attention away from what is worrying you most.
Something that might help the frightened investor is to imagine two clients, both invested in the same portfolio. One checks the value of their investments daily, the other quarterly. They will both experience the same investment returns over any set period, but the one checking daily will see far more decreases simply because they are looking at the data more often which may heighten anxiety. As your financial planner, I can help you re-set this time scale and agree a plan for how often you will check the value of your portfolio – after all, you are invested for the long haul, no cheating allowed!
The frightened investor also tends to catastrophise and scare themselves, words we should be looking out for are “what if”. Again, in a compassionate and understanding way we can talk to you about your worst fears and then work out if this actually happened, what difference would it make. Most of the time, it will be okay.
Freeze – This relates to clients that simply avoid all decisions in a crisis, overlooking good opportunities as well as bad. They become resistant to investing at any level. The stress hormone, cortisol, is firing on all fronts leading to a complete inability to make any decisions. Cues to listening out for include rapid, shallow breathing, statements of powerlessness, negative thoughts, lack of confidence and rumination. With these types of investor, we need to help them take a breath and re-gain an understanding about the long-term nature of their decision making.
Of course, we can’t change our clients’ emotions, but by engaging at this level our aim is to help manage the impact of these emotions on their long-term financial decisions.
My final point is to question “how are you feeling?”. If its any of the above, do please give us a call, after all we are here to help, and we do understand what you might be going through.