Coping with the unpredictability of financial markets

There she sat, perfectly still with a look of concentration on her face – yes cats have facial expressions too!

Quietly, patiently, she waited. What was making that rustling sound in the bushes? Was it a plaything? Was it something she could eat? Or was it merely something to be toyed with for her amusement? With her body on high alert, she poked her nose forward for a closer look, but she had to protect herself too. It was compelling, too compelling to just walk away. She had to be certain, was it friend, foe, food or simple frivolity? At last, we see it, a dinosaur (or, to you and me, a skink). The hapless creature shed its tail but she was too smart for that. She knew where the
real prize lay.

Molly’s commitment to finding out what was in the bushes, and her willingness to sit and wait, got me thinking about the parallels between Molly’s behaviour and human behaviour.

Molly needed to be certain. And so do we. The human brain is wired for survival. Its number one priority is to keep us alive and to do so, it constantly scans for threats. But our brain, in its little black box (our heads), has no direct contact with the outside world. Instead, it must wait for signals from our senses and then make lightning-fast decisions about whether something is a threat to us or not. Uncertainty, by its very nature, is a threat to the brain.

How then, as humans, do we cope with the unpredictability of financial markets, let alone life itself when our brains find uncertainty so difficult? As humans, we are generally better able to cope with bad news than we are with the anticipation of bad news. Why? Because when we know, we can act. A recent study showed that participants who had a 50:50 chance of getting a painful electric shock had higher stress responses than those who knew for certain they’d receive an electrical shock. It’s the fear, the unknown and the anticipation that causes anxiety or stress.

But there are some useful tips that can help:

1. Simply knowing that our brain dislikes uncertainty is a start. When we are uncertain, different parts of our brain are playing tug of war and that uncomfortable feeling we get is perfectly natural. Did you know that excitement and anxiety trigger similar physiological effects? We can wrestle back control by naming and reframing our emotions. That doesn’t change the external world, but it can change the way we view it.
2. Knowing that markets are volatile, uncertain, complex and ambiguous is also important. We work with you for long term benefit. What happens daily shouldn’t derail your long term strategy. In 2002 Steven Bradbury won the 1000m Olympic Skating by sticking to his game plan even as he was almost lapped by his four leading competitors. Like Molly with her skink, Steven’s commitment to his strategy ultimately saw him get his prize.
3. Speaking to your financial adviser. We can’t predict the future, nor can we give you the certainty you crave, but we can draw on our experience. We have experts who watch the markets for a living. That doesn’t mean we have superpowers to pick the super stocks, but it does give us, and you, an edge. And, sometimes, just being able to talk through your concerns can help.

In the financial markets and indeed the world, nothing is fail-safe. But your investment and your trust are as serious to us as that skink was to Molly.

After her successful slaying of the dinosaur, Molly was able to retreat to the comfort of her easy chair for blissful sleep. We hope you can too.

Please note this article provides general advice only and has not taken your personal, business or financial circumstances into consideration. If you would like more tailored advice, please contact us today.

Why do we have investment biases?

As he took the turn, he was edging ever closer to his idyllic cottage. It had been a tough week and he was looking forward to relaxing and unwinding. And then it happened, he ran out of petrol. On a country road, with no petrol stations for a couple of kilometres, he came unstuck, figuratively and literally. The cursing began, followed by a good kicking of the tyres; he wondered how he could have been so stupid. Why didn’t he check the petrol tank before leaving? He’d meant to do it, but he’d forgotten.

He was unaware that the brain’s thinking centre (the pre-frontal cortex) which sits right behind our forehead, has limited capacity, a capacity that we can increase and improve upon, but only with focussed practice. We only get so many good decision-making hours a day (and this will vary by individual).

The man’s week had been tough. Waking up exhausted, he deliberated over which tie to wear, what to pack for his weekend away, whether he’d leave straight from work or come home first, whether to have the muffin or the toast for breakfast, carefully weighing up the pros and cons of each decision. These decisions, though small, were eating into his limited brain capacity, at the same time lowering both his judgement and his tolerance.

Every decision we make, every piece of self-control we exercise (like denying ourselves chocolate to eat a raw carrot instead), no matter how big or small, chips away at that powerhouse in our head.

The brain supports us by giving us shortcuts. We can call them heuristics, stereotyping, assumptions or biases. In essence, if we have a brain, we are biased. We need these biases, assumptions and beliefs to help us navigate the estimated 11 million pieces of stimuli we receive every day (most of it without our conscious awareness). But biases also have their pitfalls. It is estimated there are around 200 cognitive biases, but let’s take a look at three of them:

Overconfidence bias

This includes a self-belief in one’s ability to pick the right stocks and to time entry and exit into the market or certain stocks. Yes, a level of confidence is good and certainly, things won’t go our way all the time, but overconfidence bias can leave us blinded to contrary indicators or red flags. In this way, it can be akin to confirmation bias (where we only consider information that supports our beliefs or assumptions and discount the rest).

Loss aversion

Our brain is more geared towards avoiding loss than towards chasing gains. A loss aversion bias could result in us not acting at all, standing on the sidelines with our cash ‘safely’ in the bank or channelling our hard earned savings into a risk-averse portfolio when, to fund our wants and dreams, we need a growth geared portfolio (which appropriately assesses and balances risk).

Anchoring bias

If I asked you whether the man’s car would cost more or less than $500 to refill with a new green energy petrol that’s brand new to the market, your guess will likely be influenced by the $500 as it’s the first piece of information you’ve been given. If I tell you that it’s only $200, it will likely seem cheap. But, if I’d anchored you at $100, $200 would seem like a bad deal and you may back away.

Any of these biases (plus the other estimated 197 of them) can cost you money.

Investing can be very personal and therefore very difficult. When things are difficult, the emotional part of our brain (the limbic system) usually comes into play. Our emotional and executive brains co-exist, but when one is active, the other is not. It’s like the rider and the elephant. The rider (the executive brain) thinks it’s in charge. But if that elephant (the emotional brain) wants to go running through the jungle, the rider is next to powerless to stop it.

Here’s where your financial advisor comes in. Backed by a team, and by each other, they are skilled in understanding your circumstances, your goals, your risk appetite, the markets and the best strategy for you. Our robust research and processes are designed, as much as possible, to guard against cognitive bias to improve decision-making and present you with objective options and advice. And, they are trained elephant tamers. Their role is to clear the path, manage the emotion and allow the rider to regain control.

Please note this article provides general advice only and has not taken your personal, business or financial circumstances into consideration. If you would like more tailored advice, please contact us today.