When markets are choppy and the economy uncertain, it is easy to fall victim to our emotions. This is understandable yet can often lead to behaviour that is less than helpful and can actually damage our chances of attaining our longer-term goals. Unravelling our decision making from emotion and focussing on some key steps can make dealing with uncertainty much easier.
The article below helps establish some rational behaviours when considering our finances.
Greg Davies, Head of Behavioural Finance at Oxford Risk, is a renowned expert on how human psychology contributes to the success, or failure, of investment strategies. Here are his tips on coping with the crisis:
1. Don’t mourn paper losses
First remember that investors only make or lose money when they actually sell investments. “Realise that in all likelihood a large proportion of your current investments are not needed for essential expenditure in the near future,” he says. “The lowered valuation of these assets is not important, only the value when you need to withdraw years in the future. You’re much better to sit tight and wait, rather than to exit when markets are down.” This is why it is absolutely vital to get the liquidity profile of your portfolio correct (this being the ease with which investments can be turned back into cash). You must avoid being a “forced seller” of assets at a time their value has fallen.
2. Stop tormenting yourself
There is no doubt that the current crisis is of unprecedented magnitude, but Davies’ next piece of advice is that investors should stop tormenting themselves by staying glued to the minute-by-minute news flow. Financial liquidity is vital, but so is emotional liquidity. In times like this many people lock in long-term losses despite not being in any way a forced seller for financial reasons. We need to conserve our emotional liquidity, and this means self-isolating from unnecessary market information. “Try to avoid watching the markets day to day as this will just increase your anxiety to no useful end,” he says. “Inevitably, there will be dramatic movements which are entirely unpredictable. Given you can’t control, or predict them, you should also strive not to worry about them, and exclude them from your long-term decisions.”
3. Think long-term (and recognise the potential upside)
“With market conditions as they are currently, it is good to remember that everyone around you is focused on the short term,” Davies says. “That ramps up the potential rewards available to those who can be patient and keep their focus on the long-term future.” It may not feel like it, but today’s market carnage could have the makings of a brighter financial future for savvy investors, he continues: “Viewed from a long-term perspective, financial assets have all just gone on ‘sale’ and could be snapped up at a large discount to normal prices.” For those who have wealth that needs to be put to work, now could be a great time to “buy at the bottom”. However, first-time investors should be very wary of simply piling in. Positioning investment portfolios well for the months and years ahead has never been more complex and robust asset allocation will be key.
4. Practice prudence – on your terms
Taking a long-term view makes it easier to see the current crisis as an anomaly that will eventually be recovered from. However, many investors will want to be extra-prudent financially, at least in the near term. Here, Davies advocates discipline and clarity of vision, both in terms of what to spend and which assets should fund that spending. “Focus on the things that you can control I would advise postponing discretionary spending wherever possible and putting inessential financial goals on the backburner for the time being,” he says. “Then, if you find that you do need to withdraw money from your investment portfolio, ensure you sell your assets intelligently.”
The composition of your investment portfolio, your other assets, broader situation and tax exposure all need to be taken into account here. A good adviser will be invaluable in helping you make these finely calibrated decisions, but Davies’ broad advice is to “start with cash, then move to bonds as these will now make up a relatively larger portion of your portfolio than they did before the drop.”
5. Use this opportunity to take stock
In times of crisis, there is a natural impulse for us to feel that we are taking action. However, it is vital that investors recognise this feeling and turn it to good account, rather than allowing themselves to make reactive (and likely irrational) moves. “Use this time as an opportunity to take stock of your long-term financial plans,” Davies advises. “This will help assuage your need to be feeling you are doing something right now, while also anchoring you emotionally on a longer time horizon.”
This article was originally posted by Wendy Spires, Director of Client Content and Research, at http://findawealthmanager.com/ on 19th Mar 2020.