We received another brilliant article written by Victoria Reuvers of Morningstar around the behavioural issues we tend to subconsciously fight as investors, especially during times like these. Most articles published in the press over the past few weeks have been filled with doom and gloom when depicting the situation we find ourselves in… and rightly so! Times are not good. Global markets have been through their worst period since the great depression. We have seen some of the largest single day market crashes recorded, with March holding the unwanted record of having two of those crashes occur in the same month (-9.7% on March 12th, and -8.3% on the 16th). Every article written fills us with panic but does not offer much in the way of support. These types of articles offer huge value through the explanation of how making emotional investment decisions can have hugely detrimental effects on our investments.
At Resolute Wealth Management, part of our role as advisors is separating emotions and investing principles from the final decision. We hope that articles such as the one below, inspire you into taking a step back before any decisions are made. We urge you to apply reason and focus on investment principles through reaching out for help before any decisions are made.
Much has been written about the initial “health effect” of COVID-19 turning into the “wealth effect” as people sit at home and have time to take stock of the economic impact on themselves, their family and friends. There are negatives and positives but the psychological effect for each person is very different.
I recently listened to a webinar by one of Morningstar’s renowned behavioural scientists, Dr Sarah Newcomb. She unpacked evidence that shows how emotions have real effects on our decision making and the ability to prioritise trade-offs. She details the effects our emotions have on us and some of the paths they willingly lead us down, many times to our detriment. Having witnessed first-hand many of these reactions from friends and family and taking inspiration from her talk, I thought it would be useful to share some of Sarah’s key insights.
Times of stress and uncertainty lead to, what Sarah calls, cognitive rigidity. What does that even mean? Well, cognition is the mental action or process of acquiring knowledge and understanding through thought, experience and the senses. Cognitive rigidity is when your emotions cloud your ability to see different points of view, weigh up trades offs and to problem solve. Basically, your brain gets stuck, our default state under pressure, an inflexible, rigid frame of mind.
Our emotional responses in times of uncertainty
While it’s impossible to remove emotions from what we are going through, we can manage the impact these emotions have on our decision making. We can do this by looking at some of our responses and common emotional reactions that come to the fore when we need to problem solve or make financial decisions.
Fear is a very strong motivator and elicits powerful and different reactions in people. Generally, fear has three responses: Flight, fight or freeze.
Flight: Risk aversion is a common reaction to the fear of loss or fear of future loss. In this frame of mind, most people will do anything to reduce future uncertainty, even if it means locking in today’s losses ensuring you have less money in the future but a more certain outcome. In essence, our actions actually caused what we are trying to avoid – losing money.
Fight: A second reaction is turning fear into risk-seeking behaviour. The instinct to fight leads to an adrenaline rush which in turn boosts confidence and a desire to gamble. In financial terms, it often results in someone changing their investment strategy in the heat of crisis and generally taking more risk. While this reaction is less common in investing, it exists and can cause a hot tip or bold change in strategy to have a hugely negative impact on one’s wealth.
Freeze: A third and very common response to fear is to freeze. This manifests itself in many people as avoidance behaviour. A straight block-out of everything that’s happening – sort of like the ostrich with his head in the sand, if I can’t see it, it’s not happening. Sometimes this can be a very positive strategy as one ignores market noise and simply leaves one’s investment alone. However, avoidance can have a detrimental effect if good opportunities and sound financial advice is ignored.
Under times of stress, we know that the body produces extra cortisol. While different from the effects of adrenaline, cortisol is known to negatively affect our ability to make decisions. As South Africans, we have to deal with many stresses on a daily basis and financial stress is just one example. I would go as far as to say that during lockdown all of these daily stresses are amplified.
Research has shown that we discount the future and place a far greater value on the present, known as present bias. When it comes to saving and financial well-being, “present bias” is the enemy of long-term financial success.
Focus on what matters most
So, what now? Firstly, take comfort in the fact that what you are going through emotionally is entirely normal and you are not alone.
If you nodded in agreement while reading about the fear of future losses and the desire to do something, we would suggest the first thing to do is to call your financial adviser and talk through your fears. You can also write down what you are worried about and what the worst-case scenarios are that worry you most.
As humans, we are particularly good at scaring ourselves by imagining extreme outcomes and scenarios. If you can visualise the future and think about what it would look like and what your life would look like, then turning the big catastrophe into a reality makes it less terrifying. In reality, the best and the worst seldom happen. The baseline reality is that we will be okay, and we will survive. We always do.
If you find yourself feeling supercharged and almost excited about what’s happening, it’s possible you may also be reading articles and speaking to like-minded people who affirm your belief. Try to think about your hot tip or high conviction idea and think about who would be on the other side of the trade and what their reasons and motivations would be for selling. If you can get a perspective of the opposite view to what you have, it can bring reason and rationality to your investment decision.
If you feel like an ostrich with your head in the sand waiting for this to pass and not wanting to look at your statement, well that’s okay too. Avoidance can be to your benefit but try to make sure you remain open to at least listening to good advice from people that you trust.
This pandemic has caused grief and pain on so many levels. The human tragedy that is unfolding is just one of the factors impacting us. Add to that the exhaustion, uncertainty and financial stress that everyone is feeling in some shape or form and we find ourselves in a really difficult position. But we can find comfort in knowing that this too shall pass. When it comes to your financial health and well-being, we can’t stop our emotions, but we can help ourselves manage the impact of our emotions and the resultant impacts on our financial wellness.
The great investor, Warren Buffett said that “few aspects of human existence are more emotion-laden than our relationship to money”. This is true at the best of times and we are living through some of the worst of times right now. Thinking about your investments can make you feel gloomy at present, but it is at these moments that we encourage everyone to stop and pause using evidence and perspective as their guide.