When the going gets tough in the markets and your resolve as an investor is put to the test, how do you react?
Do you fight, take flight or simply freeze?
While these may seem like the typical responses to danger in our lives, a new book by a Boston-based money manager argues most people fall into one of these three gut responses when it comes to their money as well.
Chris White — a financial analyst and senior portfolio money manager for Hemenway Trust Company — co-authored a book aimed at helping advisers assist their clients in managing the emotional rollercoaster that often defines investing.
Titled Working with the Emotional Investor: Financial Psychology for Wealth Managers, the book is based on more than two decades of working with investors and White’s long-standing interest in psychology.
Although its audience is advisers, the book offers much for investors, whether they’re investing themselves or with the help of a professional.
"I’ve long been impressed with just how important the emotional component is in making decisions with money," White says.
He points to a study by behavioural finances pioneers Daniel Kahneman and Amos Tversky, published in the early 1990s, "which pointed out among other things that losing is twice as unpleasant as winning is pleasurable."
Previously it was thought that the ratio was one to one, he adds.
That groundbreaking work by the eventual Nobel Prize for Economics winners led White to weave principles of psychology into his financial advisory practice — which then led him to work with one of the world’s most acclaimed organizational psychologists: Dr. David Kantor.
"His theory points to our childhood experiences of loss as being deeply influential because they are so excruciatingly painful," he says. "And it’s that sort of experience of loss that gets triggered when people begin to fear for their welfare."
What Kantor found through studying families, recording their conversations (knowingly) at home for countless hours, is that our behaviour as adults is underpinned by how we’ve chosen to shape our identity over the course of adolescence and early adulthood.
And the catalyst for how we choose to build that identity is often an event that occurs before age 10, around the time when we discover we’re not the centre of the universe, that our parents can’t fix everything and that life can be distressingly unfair.
While the identity we build for ourselves is unique in many ways, it generally is defined by one of three basic categories when we’re faced with threats and challenges: the fixer, the protector and the survivor.
"Donald Trump is a great example of a fixer," White says. "Fixers like to win even at someone else’s expense."
When it comes to investments, the fixer’s reaction when markets go down is to put more money into the market. In other words, they fight.
On the opposite end is the protector for whom relationships are "everything," White says. "A protector would never put winning at the top of the list because he or she is more interested in taking care of people and creating win-win type situations."
Think Mother Theresa, he adds.
Protectors tend to be very conservative investors. They’re risk-averse and become more so when markets are falling. "When they’re in pain, they tend to want to run away," White says. "They’ll try to sell everything."
They often will choose flight over fight — at least when it comes to protecting their finances.
The survivor is in the middle of the spectrum. Their tendency is to stay the course no matter what.
"They’ll put themselves through tremendous pain with the effort all being toward accomplishing their goal."
Nelson Mandela comes to mind here, White says.
Most people will exhibit behaviours that could fall into any of these three categories. But "when things get tough — the markets get really unstable and there are sell-offs — it triggers those childhood fears and one of these hero types really comes to the fore."
These traits can be beneficial. For example, a survivor is less likely to do anything rash in difficult market conditions and instead stick with his or her existing investment strategy. And most of the time doing nothing is the best strategy — yet only to a point.
An investor who falls into the survivor category can also be slow to change course even when it’s prudent to do so. They may freeze in the face of adversity. White, himself, he falls into this category.
"When the market sells off, I know I go through a moment or two where I’m ready to throw the towel in and say ‘It’s not worth it,’ and then I talk to myself and say ‘Come on, Chris, let’s take a look and see if there are opportunities and things we want to avoid.’ "
White adds it’s not that we need to change ourselves. That’s likely to prove very difficult — if not impossible. Instead, it’s a question of awareness.
"What I’m saying is these emotions are actually very helpful to remind us of what’s going on inside ourselves, but then we need to try to step beyond them to make more rational decisions.
"The trick is talking yourself through it so you don’t make a wrong decision."