Financial ‘physicians’ help investors diagnose problems and stick to a regimen
Psychology, not finance, is one of the most important factors in achieving long-term goals
Most people’s understanding of a wealth manager’s role is someone who looks after clients’ investments and money. But our role extends far further. Just as important is helping people achieve a deeper understanding of how, through their emotional reactions, they behave towards money, and how we guard them against the innately human tendency to panic.
Daniel Kahneman won a Nobel prize for his analysis on the inner workings of the human brain, and it is in this field where we find that psychology, not finance, is one of the most important factors in achieving clients’ long-term financial objectives. Research has found that humans tend to suffer the pain of a loss almost twice as much as the pleasure of an equal gain. Our human brain, with its emotional and cognitive biases, often leads us to make inferior financial decisions. Though events such as the Covid-19 pandemic have undesirable consequences, the markets have previously recovered every time. In the global financial crisis the peak-to-trough fall was 56% and the S&P 500 took 2.8 years to recover. Black Monday in 1987 caused a fall of 28.5% and the recovery took just more than a year.
Despite these reassuring statistics, from the beginning of this crisis to now we have seen extremely high levels of cash withdrawn and presumably hoarded in safes and under mattresses. One has to question, why do we humans often react so irrationally?
We have a very old brain — about 200,000 years old. But financial markets have only been around for about 400 years, so we seem to revert to our ancient and embedded patterns when making financial decisions. Research has shown that we use the same parts of the brain for processing information about financial risk-taking that we did in our past to avoid attacks from predators. Our brains are wired for flight or fight. Over thousands of years the evolution of Homo sapiens has favoured those with the wherewithal to attack opportunity and flee from danger.
When markets fall, we become insecure and worry they will continue to fall, so we refrain from further investing
This irrational human behaviour is expensive. When markets rise, we feel calm, excited and secure, and we are inclined to invest more. When markets fall, we become insecure and worry they will continue to fall, so we refrain from further investing. However, financial markets require patience and investing over the long term. Many statistics demonstrate this behavioural gap, and it has been repeatedly proven that individuals who work with wealth managers or sophisticated “financial physicians” have far better financial outcomes than those who don’t.
In a complex world, the role of the wealth manager has evolved to that of both a financial physician and often a psychologist. This is more apparent in the time of Covid-19 — people are more concerned about the financial effect of the pandemic on their lives than they are of catching the virus. But good financial health is generally not achieved in a crisis such as a pandemic. It is preferable to have a long-standing and trusted relationship with your financial physician, so that when a crisis strikes you are financially suitably positioned and emotionally resilient to handle the challenges. Like a normal physician, a process is involved, including the diagnosis and prescription. What really matters is to entrench the right healthy behaviours that serve over a lifetime and for future generations.
Every family or person has a unique set of circumstances (or symptoms), so it’s crucial to get this initial diagnosis correct. Whatever stage of life you’re at, a financial physician’s role is to guide you through the opportunities or difficulties you face. Clients often want to know whether they are at the end of the road in terms of their accumulation of funds or instead they should continue to work. Some people want reassurance that their money will last if they live to 100. Others might want their money to provide for the next three generations.
Identifying people in transition is another common diagnosis, whether it be divorce, death or retirement. Many want to rule from the grave, but while we are very good at our roles, our mandate does not stretch to the afterlife! This initial diagnosis should be updated with regular check-ups, at least a few times a year, to make sure the family or person stays on course and to adapt to any changes that might occur.
A good prescription after the initial meeting will blend a compound of core investments. This could include traditional asset classes such as equities, bonds, property and cash. These may need to be supplemented, depending on the symptoms, with some private equity or alternative investment classes. These are combined in the appropriate amounts that provide a solution for the particular challenge or life aspiration your family may have. We live in a world of information abundance, and while this comes with amazing benefits, the reality is that people are drowning in information.
Financial physicians should be able to distil, translate and help their clients based on extensive research, and deliver real, accurate and up-to-date information.
• Nortier is joint head of national wealth management for Investec Wealth & Investment.
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