Why is it as investors we are most susceptible to a pessimistic viewpoint over the optimistic outcome. Quite simply because we experience the pain of loss twice as much as the pleasure of gains and therefore fear is a stronger motivator than greed. This is exacerbated by the way our brain works.
Daniel Kannemeyer Nobel prize winner for his lifetime work in behavioural science and the author of the book “Thinking Fast Thinking Slow” explains that we have two separate thought processes taking place in our brains. We have our fast brain or system 1, which he also refers to as our lazy brain, responsible for all our intuitive decisions.
System 1 is our flight and fight response designed to keep us alive or should I say keep us from being eaten alive. So, it must be fast and decisive, there is no time for deliberation or doubt. System 2 or our slow brain, follows a deliberate rational thought process to answer the difficult questions, which are occasionally referred its way.
Our brain is also designed to continually be on the lookout for threats, which are referred to the fast brain for a quick response. The system worked perfectly well for our hunter gatherer ancestors as they went about their daily lives of surviving. Unfortunately, our way of thinking has not evolved to deal with the modern-day world where a tweet can cause global stock markets to lose billions of dollars in a matter of seconds.
The above is why good advice is usually trumped by the salesman selling his “snake oil treatment”. You will read or hear comments like “don’t listen your financial adviser, he has a vested interested in keeping you in the market”, which is rubbish, the easiest option is for advisers to simply switch their clients into cash at the first sign of panic. The adviser keeps his client happy and his fee paid. Sadly, this is poor advice, which inevitably forms part of the statistic of investors selling at the bottom and buying at the top. Allan Gray Stable fund is testimony to what is happening.
The chart indicates how investment flows in and out of the Allan Gray Stable fund basically track the performance of the fund for the past 12 months. Investors buy the fund when it has already gone up and sell the fund when the fund has already gone down, thus permanently destroying wealth. Shockingly I am told that most of these flows are not ignorant unadvised clients of Allan Gray, but clients paying for advice, which they clearly not getting. Keep mind the Stable fund is a low equity strategy and therefore lower volatility, you can just imagine the behaviour of clients in higher equity funds.
Now tell me, which brain do you think clients and their advisers are using when they decide to switch into cash. No prizes for guessing this one. Investors override the lessons of the past and endless research based 100 year+ of empirical evidence to make the same mistake again and again, by selling low and buying high.
So when you next read or hear the “snake oil salesman” telling you to cash-out your pension because the government is going to steal your money to fund Eskom try engage your system 2 brain, which will undoubtedly override the irrational flight and fight response from system 1 given the chance. Try frowning apparently this engages system 2
Mcomm, CFP®, HdipTax
T. 021-205 1133