Investors know what they should do – remain calm when equity markets are volatile because eventually it will stabilise. However knowing what to do and actually doing it, is something we all struggle with, especially when that something is difficult. John Astrup, Investment Specialist at Zurich Middle East discusses the perilous nature of the knowing-doing gap and how Financial Advisers can help Investors to build the bridge over it.
Over the last five years, one thing that has struck me about living in Dubai is the quality of cakes. Deriving from the land of the soggy Victoria sponge, the colour, variety and downright deliciousness of cakes in Dubai has left me feeling like the proverbial kid in a sweet shop – or should that be cake shop.
The allure of a cupcake and the inability to resist its fluffy deliciousness is actually an insight into our behaviour as investors. To illustrate my point, consider what happens when one of your work colleagues brings in a batch of lovely, mouth-watering cupcakes? You reflect on the calories and sugar in a cupcake and decide no. As you walk past and stare longingly at the box, the emotional part of your brain is choosing between delectable chocolate or yummy vanilla, while the logical part of your brain protests. Your emotions win, so you eat it!
When I’m on an enforced diet, I will often repeat the mantra ‘I will not eat a cupcake’ as soon as I experience the slightest temptation. But what is the net effect of all my self-flagellating rumination? Effectively, I have thought about cupcakes all day and I’m certain to cave in.
The research is unequivocal that a far more effective approach is to reorient that behaviour into something desirable rather than repeat messages of self-denial that ironically keep the ‘undesirable’ object top of mind.
So how does the inability to control one’s emotions manifest itself in terms of investor behaviour? James Choi of Yale found that only 4% of people who wanted to save more actually ended up increasing their savings rates. This sad number was made only slightly less pitiful when would-be-savers made a written plan; 14% were then able to stick with the program.
The official name for this phenomenon is the ‘knowing-doing gap’and its effects are powerful and pervasive. The difficulty of implementing things that are psychologically tough, even if we know them to be true is an inherently human instinct. While advances in behavioural finance can help us to bridge this gap and temper some of our emotional impulses,it will never fully eradicate the tendency of investors to make poor decisions.
Given the way human beings are wired, that may be inevitable. A behavioural economist knows that in any real-life environment, people will eat the cupcakes. One of the unstated assumptions of economics is that people have perfect self-control because they choose what they should choose. There’s a clear conflict here. One part of me wants to be thinner; another part of me reaches for the plate of cupcakes. As an investor, I know I should make a long term plan and commit to it, but it’s easier and emotionally expedient not to, especially when equity markets are falling.
Despite every effort at inoculating investors against destructive behaviour, it’s inevitable that some folks are going to panic in volatile markets which is where just-in-time reassurance, support and advice come in. I know that cupcakes aren’t good for me but I choose to eat them anyway from time to time, because I don’t have a personal trainer to slap the cake from my hand. Financial advisers can intervene at the point of maximum fear (or greed) to effectively swat down a bad financial decision as it's occurring – helping to keep your financial future in shape. Learn more about value of advice in our blog article DIY Investing Vs Advice.
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