Emotions are an important part of the wealth equation and how we let them affect our investment and financial planning decisions dictates our success to a significant degree. The key is aligning our “gut feelings” with real wealth management wisdom.
Wealth is about the hard numbers, right? Well, yes of course, but as we all know money is a proxy for all kinds of plans, hopes and fears, and so it has real emotional pull too.
I was put in mind of this issue when reading a recent research report on the investment performance of self-defined “emotional” investors which found they achieved returns of 15% against an average of 10% in 2019[i].
But the report highlighted an important positive correlation too: 55% of emotional investors consider themselves to be risk-takers, who, tending have higher allocations to equities, naturally benefited from last year’s continuation of a decade-long bull run. In other scenarios, trusting to “gut instinct” may not pay off so well.
However, the experts caution that improving as investors is not about eliminating emotional drivers, as they do serve a purpose.
“Without emotions I have no reason to care about outcomes, and thus no reason to invest at all,” says Greg Davies, Head of Behavioural Finance at Oxford Risk. “We should not strive to ‘take out’ emotions, but rather to recognise them, understand our own unique financial personality and susceptibility to them, and then to manage them effectively in our decision-making.”
We should not strive to ‘take out’ emotions, but rather to recognise them, understand our own unique financial personality and susceptibility to them, and then to manage them effectively in our decision-making
Davies concedes that over short periods just following your gut feeling may work well, since short-term outcomes are driven more by luck than skill. However, he estimates that an undisciplined approach costs the average investor 3% per year over time.
The sensible-comfortable gap
Emotional drivers might make us favour a particular investment; equally they might cause investors to flee falling markets, making paper losses into real ones just to satisfy the urge to do something.
As Davies observes, behavioural finance is about recognising that “at the heart of investment decisions is a conflict between the sensible decision that best serves our long-term needs, and the emotionally comfortable one that feels right in the moment”. “We need to find ways of narrowing this gap between sensible and comfortable, so that investors are taking decisions that are objectively right and feel right too,” he says.
At the heart of investment decisions is a conflict between the sensible decision that best serves our long-term needs, and the emotionally comfortable one that feels right in the moment
Part of cultivating the discipline to conquer the sensible-comfortable gap is seeing how heavily influenced we are by the information we consume, and how it is presented, says Davies. “Information is frequently misaligned to our long-term objectives by focusing way too much on the short-term, and on details, rather than the long-term big picture. This exacerbates the desire to follow our short-term instinct, and this can be costly.” A long-term investment plan should be your North Star, not the headlines of the day.
A seemingly widespread retreat to cash is arguably case in point: recent research[ii] suggests that fear has as much of 80% of UK investors looking to cash savings over the coming year – this despite historically low interest rates and even talk of negative ones.
Given the erosive effects of inflation (and the very real possibility for charges on cash deposits) allocating ever more wealth to cash might be far from a safe option, although the familiarity and liquidity might make it feel so.
These are just the kinds of situations where professional advisers really prove their worth, says Lee Goggin, Co-Founder of findaWEALTHMANAGER.com. “A wealth manager is a vital sounding board and a steadying hand,” he says. “Over the course of a long relationship, most people will find that they’ve been steered away from an expensive mistake of one form or other – whether that be a bad investment decision or the neglect of some part of their financial plan.”
Intention vs action
Human nature is such that we are very much capable of being worried about something and still not doing anything to solve the issue and thus resolve the resultant stressHarnessing our emotions, and yes, particularly our worries, so that we reach the tipping point to actually take action is the task we face.
Modelling and motivation
Naturally, advisers’ well-developed interpersonal skills play a crucial role here, but so too does technology, and the educative points it can make. Leading wealth managers can easily model the effects that changes to your asset allocation and or financial planning are likely to effect, and it really can be a case of “pictures speaking a thousand words” when it comes to bringing their impact home.
Leading wealth managers can easily model the effects that changes to your asset allocation and or financial planning are likely to effect, and it really can be a case of “pictures speaking a thousand words” when it comes to bringing their impact home
And so, through a combination thought-leadership, technology and trusted relationships, the best wealth managers help ensure their clients’ emotions are “pulling in the right direction”, rather than dragging them into self-defeating behaviours.
In fact, managing your emotions could be one of the most important elements of managing your wealth successfully. Good wealth advisers are perhaps best seen then as coaches or mentors helping clients see things through the right lens.
As Davies concludes: “It is not the emotion that is the problem, but the fact that the emotion tends to be focused on the wrong thing.
Managing your emotions could be one of the most important elements of managing your wealth successfully
“If we align our instinct and gut-feel to what we’re trying to achieve – long-term increases in total wealth – then our intuitions can be much more supportive of good decision-making.”
[i] “LGT Private Banking Report”, 2020
[ii] HYCM, Aug 2020
[iii] “Money and Mind Report”, Schroders