One of our Chartered Financial Planners, Ross Mackie, asks a vital question. How can we be better investors and make more effective financial decisions? The answer is usually to go against our natural instincts, which is difficult to do on your own. But fear not, says Ross, good financial advice can save us from ourselves.
As human beings, we are built to react in instinctive ways when faced with stressful situations; particularly unexpected or surprising ones. If a bear jumped out at us on a peaceful stroll through a forest (admittedly unlikely in Charnwood), we are hard-wired to either fight the bear (not recommended), or to run for the hills, (more likely).
You’ll know this as our fight or flight response. The way the human brain has evolved over time has generally been to protect us so that we survive as a species. Fast-forward just a few thousand years from when we were cavemen running from sabretooth tigers, and our brains are still geared towards survival.
As a consequence, we are not generally built to be good investors. Our emotions and natural tendencies as human beings often get in the way of how we would behave if we were to take a more rational - and profitable - approach.
When the coronavirus took hold of the world in March 2020, for many of us our fight or flight response kicked in to affect our decisions, including those around money and investing. This led to most of the country being shut down and at the same time, stock markets around the world slumped. Understandably, some of our clients were concerned about whether their investments were OK. Should they fight (which felt less attractive), or flee (which felt right)?
No wonder that people who sell in a crisis have come to be known in investment parlance as 'bears'.
Emotion vs Logic
A few clients questioned whether they should sell all of their investments and ‘flee’ to the relative safety of cash in the bank. As their advisers, we listened to their concerns and took time to understand each person's own unique circumstances. We were able to point our clients to overwhelming evidence that demonstrates that ‘panic-selling' investments when they are low, is likely to lead to worse long-term returns than remaining fully invested. If you are going to sell, do so when prices are high. It's when they are low that you probably ought to be buying by investing more. That’s what rational investors do.
Yet it feels all wrong. When everything seems uncertain our natural inclination is to protect ourselves by running out of the forest. Faced with an angry bear, the last thing I would recommend is that you go and seek other bears to annoy. Running away is almost certainly the best advice.
But it's entirely the wrong response when you make decisions about money. Recognising this clash of logic over emotion is one of the most important lessons you can learn on your journey to financial freedom. You need to be able to put your emotions to one side and look at the facts.
Buying investments is similar to going shopping. The best time to buy something you want is when it is on sale. When investment prices fell in March 2020, professional investors saw it as sale time in the stock market and moved in to pick up bargains. But most people don’t think about investing in this way.
The Voice of Reason
One of the benefits that a financial planner brings to the table is to be the voice of reason at such times. Money can be a highly emotional subject, but as financial planners we can help people to see beyond their current feelings, to look at things more objectively, and to help them to take sensible actions.
There is plenty of evidence to demonstrate that investors working with a financial planner get better results than those going it alone. By challenging thinking, suggesting appropriate behaviours, and coaching clients to be better investors, our guidance and expertise can add significant value to our client's lives, empowering them to go out and achieve their life goals, for the reasons that are important to them.
And that's a great result for all of us.
Chartered Financial Planner
If you enjoyed this article you may also like: