From the November 2011 issue of Investment Advisor • Subscribe!

November 1, 2011

Change What You Can, Bear What You Can’t

Financial planners should consider behavioral finance principles to protect clients from their own fears

A funny thing happened one day in early August when the markets hit panic mode. I spoke with a few reporters and even fewer clients. I fielded two calls from concerned clients—one whose son had planted a significant seed of doubt in her mind and another who just wanted to hear my voice; since she didn’t hear any hint of panic, she went on to share the great news that her son had landed a very good job, very close to my office.

As financial life planners, we devote a great deal of time discussing volatility, market reactions and panic—we talk a lot about the dangers of buying into this mindset and about the fact that emotions are best devoted to loved ones, music and art. Such was the tone in my world. Not so in the world around me. The world at large was predicting a double-dip recession, pointing the boney finger of indignation at Washington, Greece and Italy.

At the end of that day, I ran into an attorney who works in my building. He offered me words of sympathy, saying something about what a rough day I must have endured. I tilted my head and asked what he meant. I knew.

His look of sympathy was replaced by confusion—he expected a different response. I explained that as financial life planners, we don’t buy into market emotions and try our very best to prepare our clients to get through trying times. It’s all about time, understanding the different risks we face and staying focused on our goals and values. He walked to his car asking me if I might have some time for him next week.

That evening, I dumped a precious 90 minutes of my time reading various articles, tweets and pronouncements citing rational reason and statistical and historical precedents for this latest round of market woes. I read many points of view and interesting facts and near-facts, but came away without a change in my thinking.

As a nation, as a world, we need to examine our own financial underpinnings and take more responsibility for understanding risk. We must examine our values and our needs (as opposed to our wants) and make sure our own financial lives are in order. Risk is everywhere, but those who believe they can extract consistent profits by short-term trading are most probably incorrect.

We can react or overreact to inevitable down times or we can make sure our long-term strategies are in alignment with our long-term risk tolerance and our long-term needs. We can make sure our short-term assets remain liquid, safe and available to support us through the tough times. We can make sure we are not swimming in debt and live within our means. If we do those things, then these times of upheaval, whether they last a day, week, month, quarter or two years, will not impact our overall ability to succeed.

Economists, analysts, stock pickers, market timers, politicians and members of the media always have something to say—it’s their job to explain what is happening and why, and to predict what will happen next. Consumers who hear the various messages react and typically pay a very dear price. The world will do what it will do—the market will react, predict and move based on its own set of beliefs. We cannot change that; instead we can only change our behaviors based on knowledge, experience and well-thought-out strategies based on comprehensive thinking.

A great resource on this perspective is Meir Statman, Ph.D. and author of “What Investors Really Want,” who explains in very friendly terms how we think and why we make mistakes over and over again. He understands how our behaviors support or distract us from success.

Take a breath. The ups, downs and sideways of the market will occur without any of your help or participation. We will get through this and there will be periods of stability and growth—until the next time.

 

Michael Kay, CFP
President
Financial Focus LLC

Reprints Discuss this story
This is where the comments go.