This may sound pessimistic but unfortunately, it’s not an incorrect statement. It refers to our human behaviour when it comes to investing – the investor behaviour.
The investor behaviour needs to be managed via the disciplined but simple recommendation of ‘no change’ which most of our clients have experienced for years. It’s simple but effective. It may sound repetitive and even boring, but without it we would all end up chasing the annual ‘The top 5 stocks to invest in 2019’ type of headlines (and end up broke).
As huan beings, we are bound by a number of complex but natural preconceptions which literally stop us from acting rationally while investing throughout our lifetime. This set of biases basically prevents us from processing reality in a rational way and makes us incapable of executing and sustaining a successful investment strategy that can last a lifetime.
The next thing that’s important to acknowledge is that these matters are cognitive in nature and therefore can’t be ‘fixed’ by investor education, as is so often suggested by media and Barefoot Investor type literature. We can’t overcome human nature by learning, just as we can’t change left-handed writing with psychotherapy. Understanding is an intellectual issue, and we’re all capable of that. However, processing it correctly and accepting it is an emotional issue which requires close partnership with an empathetic but tough loving, third party investment adviser.
Fear is by far the biggest inhibitor of wealth building. We are all equipped with a processing centre of fear in our brain – the right amygdala. This fantastic piece of hardware used to help us process fear and anxiety when running away from a lion in the savannahs of Africa over 40,000 years ago. It instinctively guided us to stick together with our herd or to run away and save our skin. It was essential for our survival back then but it’s not doing us any favours now when facing the fear of capital markets. Whether it’s fear of loss when seeing our investments (temporarily) reducing in price or fear of missing out when seeing others making money (incorrectly branded as greed by media), it’s always fear. How we naturally respond to it contributes to our inability to deal with it the right way.
Human beings all suffer from what’s called an asymmetric loss aversion, which simply means that losing money feels twice as bad as making money feels good. This, combined with our difficulty in distinguishing between a temporary market decline and a permanent loss, ensures casualties in every market correction. Together with the media fed thesis of ‘This time it’s different’, it enables the investor’s tortured psyche to escape not only from the pain of ‘loss’ but also from any obligation to continue investing rationally.
This refers to our inability to distinguish between currency (medium of exchange for products and services) and money (stockpile of purchasing power). It’s culturally unavailable to our human mind that at just average inflation of 3% pa (the average rise in cost of living), what costs us $1 today will cost us $2.44 in 30 years’ time. The erosion of purchasing power will devalue every dollar we own by almost 60%. No one is paying attention to it on a daily basis (because we can’t) but it makes all the difference in the long run. It wisely forms the reasonable basis to invest our savings but our human mind just gets distracted.
What we perceive to be a good investment and the way we define risk and safety are fundamentally flawed. Our mind works completely fine when it comes to making every day financial decisions, but when it comes to investing (in shares) it never does. In all economic decisions we make regularly, when the price of something reduces (everything else being equal), we’re naturally drawn to it. Discounted prices offer good opportunities to get more value for money. The converse is also true – when the price of say business suits increases, we stop buying them and wait until the mid-year year sale. You know what I’m talking about when I say I feel extremely proud, I bought two suits and a shirt for a price of just one suit. It brings us pride and joy, and rightly so.
In relation to investments, when the price of an investment is rising, all the fundamentals tell us its value is reducing and the risk of investing in that asset is now higher so we should be more cautious. Conversely, when the investment prices temporarily fall (typically because of some imaginative doom and gloom prognosis), economic fundamentals tell us that the value of investing in those assets increases, the risk is reducing, and we should increase our appetite to buy more. Tragically, human nature makes us do exactly the opposite. We step up our purchases when markets rise (pretty close to the top) and we sell what we own when markets fall (pretty close to the bottom) and we keep doing it until we go broke. Our perception stands in the way of making the rational investment decisions.
As I already mentioned at the start, this is a normal, human reaction and it has nothing to do with what we know. It has everything to do with what we feel and that’s why we all need a helping hand to stop us. Our human nature needs someone to stop it from essentially destroying us.
Only your financial planner can do that for you and discourage you from making a wrong decision by so often saying, don’t make any changes or don’t react. In its pure essence, it’s the most important recommendation we make. Even if it means no change. It’s about the ability to stay patient and disciplined when others lose faith in what they’re doing. We call it the ‘Zen of Investing’ and it’s the only way to enjoy the benefits of the compound interest we all strive for.
Does your investing behaviour need some professional support?
Speaking with one of our financial planners could make all the difference. Make a booking or call us on 02 9328 0876 to arrange a meeting.
Aricle by Michal Bodi
General Disclaimer: Originally published by The Sydney Morning Herald on 13 October 2018. This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. Please seek personal financial advice prior to acting on this information.
Photo by Tyler Miligan on Unsplash