“The market is too high – get me out before it crashes!”
This is what Rudy said to me when I answered his phone call on December 2, 1996. Within an hour, I received the exact same message from Edwin. Neither of these gentlemen knew each other, but it was as if they did.
The S&P 500 Index closed that week at 757, up 25.1% from the previous 12 months and up a whopping 66.7% since the first week of December 1994. Rudy and Edwin, both in their sixties, wanted to get out and take their profits, wait for the market to go down, then buy back at fire-sale prices. That never happened.
Rudy and Edwin “got a hunch and sold a bunch”. They acted on their feelings not the facts.
In the late fall of 1996, our Chief Strategist, Chuck Clough, was saying corporate earnings estimates were good and valuations were healthy. Most of the “street” believed the same. Even though the market had experienced a great run in the past couple of years, causing Rudy and Edwin to make more than they expected, it looked very healthy and we expected markets to move higher. The markets did in fact move higher, without Rudy and Edwin.
One year later the S&P was up 26.2%, and a year after that it had gained another 21.9%. Rudy and Edwin never got back in because of a behavioral economics term called “loss aversion”, which refers to people’s tendency to strongly prefer avoiding losses to acquiring gains. Loss aversion was first demonstrated by Amos Tversky and Daniel Kahneman, and suggests that losses are twice as powerful, psychologically, as gains.
Rudy and Edwin didn’t lose any money in the stock market, but they did lose opportunity. They had planned to buy back into the market at lower prices. They simply acted on their feelings, ignored the facts, and in doing so missed a lot of opportunity. Both suffered from seller’s remorse and stayed fixated on the re-entry point that never came.
The fact that losses are felt two times stronger than gains, is a primary contributor to the stress level of Financial Advisors. People hand you their life savings and say, “Make me money…and don’t lose any of it!” A recent survey indicated that 83% of Advisors said shouldering the responsibility for clients’ financial futures created the highest level of stress for them (ThinkAdvisor.com). I overheard one Advisor say recently, “Markets aren’t rational, and neither are my clients!”
Since many of our buying decisions are emotional, remorse can be a common after-affect of a purchase. Regret over the 55″ TV you purchased may be real, but it’s much easier to get over than the bet you made to sell all your stocks and go to cash after the market plunged 50% in less than a year. (This actually happened in 2008 – the S&P is up now over 130% since then)
What’s my point? Investment decisions should be based on facts, not feelings.
I wish my efforts to convince Rudy and Edwin not to bail out of the stock market had worked. The old adage, “The client is always right”, isn’t true. But one thing is true, “The client is always the client!” It comes down to the fact that it’s their money, and their decision. We all feel euphoric and over-confident when things are going well for us, and we feel terribly inadequate and incompetent when our world is falling in around us. Whether it’s investing, our job, children, geopolitical events, etc., our feelings move us more than the facts.
That’s why you need a good Financial Advisor. She will help you focus on the facts, and not your feelings. A good Advisor will guide you away from index performance and toward goals based planning. He will hold your hand when waters are choppy, and remind you of the long term reasons for your decisions. A good Advisor will help you avoid the short term amnesia that accompanies difficult markets by reminding you of the truth.
The #1 reason you need a Financial Advisor…to protect you from you!
Trust in the facts, not your feelings. Trust in your Advisor not your hunches. And avoid being a Rudy or an Edwin!
Check out these resources to find out more about how your emotions affect your behavior and why a good Financial Advisor can help you mitigate them:
- 6 minute video: “How Volatility Affects Us As People”, Michael Liersch, Head of Behavioral Finance, Merrill Lynch
- “Investor, Know Yourself”, Wall Street Journal (short quiz to help you understand what’s going on inside your head)
- Email us for list of the things we look for in an Advisor: email@example.com
Bill Edmonds is an “Outside-Insider” (an Executive Coach and Consultant), who works with market place leaders to help them reach their full potential in the areas of organizational and personal development. A former Financial Advisor and Market Leader, Bill spent 24 years with Merrill Lynch until his retirement in 2014, where he led a $100+ million per year revenue wealth management business unit as a Director with the firm.