by Thomas Skinner
Experts will tell clients that the recent market losses are part of the investment cycle and that they shouldn’t feel anxious.
But what if clients still feel anxious? What if, this time, it is different?
As adults, we’ve learned to control some of these emotions, but when we’re told not to feel something that we already do, we get upset and panic.
This is because whenever we look at our investments at any point in time we “anchor” the value in our mind. Each time we log in or receive a value by post, we store that figure mentally. Naturally, when the figure moves upward, we are pleased.
But when it moves down, particularly at an alarming rate as was the case last week, we react very differently. We feel an emotional reaction far greater than an equivalent increase in value, which is illogical. Winning a tenner should feel exactly the same as losing it. But it doesn’t. Particularly if we view a value as something that is already ours.
This cognitive bias, as these mental peculiarities are known, is called loss aversion.
No amount of pastoral guidance in these heady times will make clients feel any less anxious about your crumbling stack of lifelong savings, as the new value moves away from your anchor, each time you look. However, you can give clients a sense of control by presenting these losses as an opportunity.
Successful investing is often about doing the complete opposite of what feels natural. That's why successful investing is so hard. Intuitively, it doesn't feel right. Clients think, why would you invest now?
That's why it's critical to explain to clients that by investing at lower prices, they will also lower the average unit price within a portfolio, which is a very good thing. If a client is more than 10 years from retirement, their retirement prospects and the future return on their capital have just increased, dramatically because of the recent stock market crash. If and only if, they invest at these new prices.
Thankfully, a great deal of their future investment capital will be made through regular investment each month at these new, seemingly unfavourable, lower prices. The sudden fall in asset values creates greater prospects for investment returns. Paradoxically, before the crash, the growth prospects of these future regular premiums were poor. As we now know, the market was at a peak. Clients should view their future investment contributions as an asset in their own right.
To illustrate this, we have begun to model a 50% stock market decline and, importantly, allowed for a slightly higher expected rate of return (ERR) on all future regular investment. For example, a medium risk investor might expect the future expected rate of return to be 6%, after fees. Whereas and until recently, we may have modelled that the same investor, with the same level of risk, could expect a rate of return of 4%. Actual returns will vary but these are reasonable assumptions, based on the analysis of asset returns pre and post severe market declines.
Every bull run feels like it will never end. Every stock market crash feels like the beginning of the end. It's important to explain to clients that if they don't continue investing, every stock market crash will eventually feel like another great opportunity missed.
Tom is a founder, Financial Planner, and the Managing Director of Barnaby Cecil. He is married with two boys, Otto Barnaby and Charlie Cecil. His focus is to understand the psychological aspects of finance and link this to a meaningful and fulfilling outcome. An avid reader, his planning principles have been heavily influenced by the works of Kahneman, Taleb and Bogle. This approach helps him understand human behaviour and how this translates into solutions that allow his clients to maximise the utility of their wealth. He works closely with Emma Walker to develop bespoke and innovative financial plans. Read his profile here.
