Medicine and investing: Two games which are extremely tricky to navigate. Two games that leave physicians and investors at the mercy of vast information processing hubs: The human body and the market. While medicine has been perfected over the years, practice hasn’t always made perfect for investors. Unlike medicine, investing appears to have no standardized science behind it. And don’t forget every investor’s kryptonite: Volatility. Why? Volatility can drive irrational investment behavior.
Money is Emotional
Successful marketers understand that the most effective messages stimulate consumers emotionally. This gives us a unique look at the human psyche: Emotions drive behaviors.
One would be hard pressed to prove that money isn’t emotional, or even the field of medicine for that matter. Think about it: Expanding medicine into uncharted territory; crafting revolutionary surgical methods; reigning victorious over deadly diseases. This emotional feast is why physicians continuously push the limits of modern medicine. For investors, volatility is the predator that feeds on our emotions; enter irrational investment behavior. Prompted by spikes in volatility, emotions drive investors to endlessly try and craft the winning formula for market performance.
Science provides answers in medicine and grounds physicians in their emotional pursuits. It’s proven, tangible and unchanging. But what science is there for investing? Unlike science, everyone has an answer for what works and what doesn’t. This is precisely why investors fail at consistently crushing it in the market.
Just How Vulnerable Are We?
If financial behavior has taught us one thing, it’s that we’re more vulnerable than we know. This is because we have a hard time realizing when we’re being manipulated, especially when it comes to investing.
Interestingly enough, we’re just as easily manipulated by others (noise) as we are by ourselves (emotions). To overcome this financially lethal combination, we have to understand the emotions that drive detrimental behaviors. Then, we can formulate a science behind investing that overcomes these.
“Dow Plummets 331, Oil Drops Below $50.” “Stocks Slide on Oil, Economic Fears.” “Dow’s Charge Turns the Year Positive.” “Dow Soars 323 Points, Erases 2015 Losses.”*
All of these statements were headlines that ran in the Wall Street Journal and USA Today in January, 2015. When the catastrophic headlines dropped in investors’ laps stomachs churned. Losses were immediately assessed. Feelings of defeat were rampant. But, you don’t surrender to defeat when a surgery begins to go awry; you stand your ground. The booming headlines followed the catastrophic ones by only two days. Those who were driven by the fear of what may come next and acted rashly were now tending new wounds.
Volatile times in the market are magnified by the noise surrounding investors. Too often, noise effectively manipulates us into thinking we’re acting with the best intentions. Remember this: Disasters have been the result of the best intentions.
Track Records & Forecasting
Investing is a means of preserving our future. Investing also carries risk. What a conundrum; no wonder we will listen to every source of information we can.
The fact is that financial loss is felt much deeper than financial gain, similar to how the patients you lose can stick with you longer than the ones you save. Hence, why we go to great lengths to avoid risks more so than finding the right times to capitalize. Triggering these emotions, volatility entices us to seek the advice of market forecasters. Many endure arduous journeys of investment selection based on past performance. However, no one can tell you when earnings will explode or chaos will ensue. Past performance has little to no impact on tomorrow.
Everyone has a solution: From talking heads in the media, to your friends, to your advisor. But, attempting to time the market or forecast its behavior can cause you to get burned by huge losses. As Warren Buffet says, “Market forecasters will fill your ear but never your wallet.”
Holistic versus western medicine, active versus passive management: Battles that have raged on for decades. While hybrid medicinal practices have progressed, investors would also do well to recognize that elements of both are beneficial.
Unfortunately, volatility screams for us to act when positive spikes occur and to question why we’re holding when drawdowns happen. This is the exact moment where optimism and confidence can enact irrational behavior. While these are essential personality traits for happy human functioning, volatility can quickly blur the lines between optimism and realism, confidence and cocky. You’re king in the operating room, so you’re king of the market too, right? Regularly trading stocks in order to beat the market only guarantees one thing: A high friction portfolio with large fees coming out of your pocket.
History has proven that fund managers regularly trail the market. Instances of out-performing are rare, and even harder to duplicate. Time IN the market should be your first priority (passive), adjusting for risk tolerance, time frame and tax impacts along the way (active).
Unlocking the Science: Your Personal Investment Philosophy
The majority of us would say our goal is this: to make our money last forever. Now, where’s the plan? Remember, a goal without a plan is simply a wish.
Finding your “why” is a critical first step in discovering the science behind investing. Why is money important to you? Why are you investing? Why do you value certain principles over others? Putting many things into perspective, this helps us understand three vital points in formulating a sound reasoning behind our actions:
- Where your money is.
- What your money is doing.
- Why your money is where it is and doing what it is doing.
This ensures that your investing behavior aligns with your personal philosophy and no one else’s. And when we understand the “why” behind our actions, the self-destructive impact of emotionally driven impulse can be overcome. We can’t say when or how volatility will strike. But, I can tell you this: Storms will happen. It’s how you weather the storms that separate success from failure. And our clients are well prepared to stand on the side of success.