May 18, 2020
At Ronald Blue Trust, we offer strategies and principles to help our clients navigate through all of life’s seasons, including periods of economic disruption. We believe identifying your behavioral biases and prioritizing your financial goals are essential to your investment strategy and can help you withstand periods of market movement. Today, as part of our “Navigating Economic Disruptions” series, we will look at how to weigh emotions and biases when choosing an investment strategy that is right for your goals, which can help you through periods of uncertainty.
The following was written by Michael Cranford, a Private Wealth Advisor in Ronald Blue Trust’s Charlotte, North Carolina, office.
As an advisor, part of my job is to help our clients identify their behavioral biases early in the investment management discussion. This responsibility is important even when the economy is going through an expansion so that investors are prepared when recessions occur. Identifying my clients’ behavioral biases has allowed many of them to have a sense of calm during the recent economic shutdown. However, I can imagine some investors contacting their advisors with concerns such as these:
Scenario 1: “Hello, this is Tom. I just opened my statement. I know things have been rough out there, but I saw that my wife and I lost $10,000 last month! That’s four months of income from our portfolio! I just don’t think we can afford another devastating drop like that. I think I want to go ahead and sell all of my equities now while I still have something left.”
Scenario 2: “This is Jay. Have you seen these markets? The U.S. really seems to be bouncing back, but I just don’t see that reflected in the numbers on my statement. Is this because we are diversified globally? I get that, but I sure don’t want to miss out on a big run up in the U.S. market.”
Scenario 3: “Good morning. This is Beth. With all of this mess in the markets and the economy, I wanted to reach out and see if you thought we should go ahead and change my husband’s and my retirement age to 75 in our plan assumptions. Who knows if the market will ever recover? Let’s just sell to cash, and we’ll keep working. We never did want to rely solely on our savings anyway.”
Tom, Jay, and Beth–these are fictional characters who represent common perspectives. They have different goals but a common theme: fear. Uncertainty is a reality in life and in financial planning and investing; in periods of heightened uncertainty, fear abounds. In fact, fear as an emotion is so often associated with investing that the CBOE Market Volatility Index (VIX), which measures the implied volatility of S&P 500 Index options, is commonly referred to as the “fear index.” Fear is mentioned over 500 times in the Bible. Fear and, more broadly, emotions, play a role in our financial and investment decision making. Many of us base our decisions on how they make us feel or on a feeling we have about a particular subject. These reactions are what we refer to as behavioral biases.
In our scenarios above, Tom, Jay, and Beth have different investment goals and manifest their fears and biases in different ways.
- Tom’s goal is to limit experiencing big drawdowns and market volatility through a “Fear of Loss” (FOL). He doesn’t want to lose money, even if $10,000 is only 2% of their portfolio. While he knows they need to invest to preserve their portfolio, preservation feels much better when the numbers stay flat or positive. Tom has a sense that whatever steps were taken to lower the risk of loss and diversify their portfolio, the odds are not in their favor.
- Jay’s objective is to keep up with his peers and major benchmarks (such as the S&P 500), also known as a “Fear of Missing Out” (FOMO). He saw the U.S. market skyrocket after the Great Recession, and he doesn’t want to lose out on another opportunity. He doesn’t fear investing and losing money in the long term, but rather he fears investing and not making as much money compared with the S&P 500.
- Beth’s goal is to have enough funds to meet her future cash needs so that she does not experience her “Fear of Failure” (FOF). Her anxieties are not related to certain percentage declines in the markets or the possibility of missing out on the next big buying opportunity. Instead, Beth fears that her vision for the future will change and she will not have adequate cash flow to retire or travel like she has planned. She resigns herself to the abandonment of her dreams, which feels more reliable and less risky.
If you find yourself relating to Tom, Jay, or Beth on some level, you’re not alone. Perhaps at various times you could connect to all three of our characters. I have observed that most of us relate to having an investment goal and a little of each of these biases woven in our hearts–fear of loss, missing out, and failure. As an investor, it is important to recognize which of your individual goals and biases take priority in your mind. You may become conservative in your investment approach to preserve your assets, but over time become dissatisfied by unexciting investment returns. Whatever investment biases you may have, make sure your portfolio takes these emotions into consideration. After all, your best investment strategy is one you can have peace about regardless of the economic season, and the way to determine this strategy may be to see how you process these emotional responses to market uncertainty.
To read more about investor biases and the role they play in behavioral seasons, please click here for a white paper written by our investment team. We believe investors who understand the nature of behavioral seasons are more likely to weather challenging periods and meet their long-term goals.
If you would like to speak to a Ronald Blue Trust advisor about your investment strategy, please call 800.987.2987 or email [email protected].