We often act from the heart rather than the head – much of what we do and how we choose to respond to a situation is based on our emotions. This is what makes us super-consumers – do we really need the newest car model, cellphone or pair of shoes? Or do we like the way these items makes us feel? And while emotions are part of what makes our life worth living, they’re not our best partner when it comes to making financial decisions.
While we possess inherent behavioural biases based on our emotions (for example, how we feel about money, seeking financial advice, or following a hot investment tip), financially savvy individuals know that to make wise investment decisions, they need to constantly check their emotions.
Being aware of these emotions is the first step to countering impulsive financial decisions. Emotions like fear and greed, for example, can be powerful drivers when it comes to managing your money. Pandering to these is a sure way to ensure the destruction of wealth.
Just like our emotions, financial markets are cyclical in nature. The combination of these two factors magnifies the boom-and-bust characteristics of these cycles, with the bottom of the market most often leaving investors feeling the most pessimistic and depressed.
Consider this example – in 2008, the JSE All Share Index dropped over 45% in the six months from May to October. Not only did this have a huge impact on individuals’ wealth, but it was also an extremely emotional period for investors, with many panicking about the state of their portfolios. We should be buying low and selling high, but these emotionally trying times will often make us do the opposite.
With the benefit of hindsight, this turn of events presented a compelling opportunity. Investments in large, reputable, multinational companies with good growth potential were now on sale at a 45% discount – what a bargain!
However, with fear of the global credit crisis as their primary driver, most investors did not buy shares – they sold instead. The result? Significant losses on their investments. If those with the finances to do so had bought rather than sold, they would have experienced fantastic returns in the aftermath of the crisis. Billionaire investor and philanthropist Warren Buffett summed it up best with the adage: “Be greedy when others are fearful, and fearful when others are greedy.”
Another inherent weakness to note is that we often assume that the current situation will continue forever. This is hardly ever the case – life is change, whether it’s a slow economy or a weak currency. Think about the rand/US dollar exchange rate. Only six years ago, very few clients considered moving funds offshore – the rand was R7 to the dollar and many believed that the rand would continue to strengthen because it had been appreciating for some time.
However, this did not last. Fast forward to a year ago, and the rand had plunged spectacularly to almost R18 to the dollar! This sharp depreciation caused many investors to follow their gut and move offshore, resulting in them suffering significant losses to date. Panic results in rash decisions and these can cost you money.
My advice? Don’t make financial decisions based on emotional responses alone. Step back and evaluate the situation with a logical mindset. And get sound advice – speak to your financial adviser about your portfolio, your wealth goals and the state of the market.
No one can foresee the future of the markets, but your adviser can bring experience and expertise to assist you in managing your wealth plan, helping you to counter an irrational, emotional response to your financial situation. Such a response could cost you much more than just a sleepless night.
Devin Shutte is the head of investments at The Robert Group, a private wealth management company.
This article originally appeared in the 9 March edition of finweek. Buy and download the magazine here.