Nothing in life is to be feared. It is only to be understood.
– Marie Curie
Fear and Money
Fear. A simple yet powerful emotion, and an unavoidable part of our lives. Throughout history societies have been continuously shaped by fear, and the decisions resulting from that fear. Fear of danger, fear of the unknown, fear of loss, fear of failure, the list goes on and on. Neanderthals living in caves out of fear for their lives. Ancient Egyptians mummifying their dead to protect against the dangers of the afterlife. Roman emperors ruthlessly crushing dissent for fear of losing control of their empire. Investors fleeing a plummeting stock market out of fear for their life savings. Different eras in history, different regions of the world, different consequences, all based on the exact same feeling.
Unfortunately, the fact that fear is often completely irrational, and ultimately futile, does nothing to weaken its powerful grip on our behaviour. At first glance these extreme historical examples would seem to fall beyond comparison with the scenarios we encounter in today’s modern world. However, upon closer examination it becomes clear that in each of these cases we find it is the underlying desire to avoid loss – in whatever form that may take – that remains constant. The effect this motivation subsequently has on the way we perceive our lives and our expectations for the future then has a profound influence on the choices we make. And as 21st century investors, these are the choices that will shape our financial futures, and the futures of our families. The challenge we face is to choose our own path, not let fear choose our path for us.
Most investors with a basic understanding of the financial planning process are aware of the main areas that need to be addressed:
- Assets and liabilities
- Cash flow
- Time horizon
- Goals for the future
But there is a fifth dimension in financial planning that is arguably the most important and influential when it comes to creating a financial plan that you can be comfortable with, and disciplined enough to stick with regardless of the challenges you may face. That dimension is emotion. It is all well and good to crunch the numbers, devise a plan, choose an investment strategy and envision future results based on a series of reasonable assumptions. But what happens when things don’t go as planned? Or are still following the overall plan, but with a level of volatility you hadn’t imagined when plotting this course? These are the moments when emotion threatens to derail your carefully laid plans. Even the most brilliant and comprehensive financial plan quickly becomes wasted effort if you lack the discipline to implement it as it was intended. All too often people take great pains to develop the perfect financial strategy for their situation, only to abandon it as soon as changes occur they hadn’t mentally prepared for. Market fluctuations, political upheaval, global financial movements, terrorist attacks, or even natural disasters are all examples of unforeseen factors that can influence our financial well-being and tempt us to disregard the strategies we have so carefully designed. And, while fear is the most common, it is certainly not the only emotion that can lead to a lack of confidence in our current direction. Greed is also a powerful motivator and can often be just as damaging. We would like to have a nickel for every time a conservative, risk-averse client with limited discretionary cash flow came to us during a bull market suddenly interested in dumping some of their thoughtfully chosen long-term investments in order to purchase shares in some high-risk, high-reward securities in hopes of biting off a bigger share of a booming market. Never mind that by the time the average timid investor is finally convinced that the market offers only joy and riches you can be relatively certain that the good times are almost past. The real issue is that those strategies so meticulously calculated two, or three, or five years ago took into account this very possibility but judged the risk to be too great based on the specifics of your particular situation. Markets can’t be chased, at least not successfully. But we’ll get more into that later. For now, the lesson to be learned is that once your plan is in place there is no room for changes based on moods, whims or feelings.
Of course, that is not to say you won’t feel these emotions, only that you need to restrain yourself from acting upon them. Financial worries are one of the most common, and probably most damaging, types of stress we face in our lives today. With growing global uncertainty, rapidly advancing technology, an exponentially greater number of financial options than ever before, and a trend away from highly funded pension plans and toward individually managed retirement portfolios it is no surprise that concerns about money have the power to keep us awake at night. Throw in a global financial climate in which nations and markets become more interdependent with each passing year and it is no wonder the very topic of financial planning has the power to frighten us.
It is not only the big picture, however, that can adversely affect our mental state when it comes to finances. In 2010 the government’s Task Force on Financial Literacy determined that 42% of Canadians lack basic literacy in financial matters, and that 55% describe money as their main source of stress. Another interesting statistic from the same report tells us that 70% of Canadians live from paycheque to paycheque, which essentially means they have no flexibility to deal with unexpected circumstances. And when you are aware that you simply cannot afford for anything to go differently than planned it stands to reason that you would worry about just such an occurrence.
Another major factor is debt. Continuously increasing personal debt levels in Canada today are leading to more tension for people concerned about making their payments. High debt ratios tend to make people behave more conservatively when it comes to their portfolios. Of course, everyone is also aware of the role excessive unregulated debt played in the 2008 market crash, and that knowledge only adds to the anxiety people feel with regard to their mortgages and lines of credit. Accordingly, as debt levels have risen, savings rates have been steadily decreasing since their peak in the 80’s when they came close to 18%. Currently, the overall savings rate of Canadians has dropped to less than 5%, which is far less than most people need to save to ensure a reasonable future retirement.
In today’s Internet age it has become progressively more difficult to sort through all the options and advice that are available on a daily basis. The number of financial vehicles continues to increase every year, making it more and more difficult to narrow down the appropriate choices for your situation. Meanwhile, the amount of often contradictory advice bombarding us from TV, books and the Internet, in addition to that plethora of options, has made decision-making next to impossible without the guidance of an experienced financial planner. To make things worse, very little of this public advice is actually designed to help individuals plan their futures wisely. For the most part, on the Internet in particular, the main goal of these articles and websites is simply to arouse the emotions of readers. They often attempt to draw attention by using inflammatory headlines and misleading claims, racking up readership and “hits” with little to no regard for truth or responsible reporting. Some articles are even less transparent, created for no other purpose than to incite the fear and uncertainty needed to convince people they need to purchase whatever product it is that the story inevitably hails as a magic solution.
Of course, that is not to say there aren’t still many responsible reporters, writers and financial advisors out there who provide useful, unbiased information in the interests of educating the public or their clients. The problem lies in determining which ones are real and impartial, which are exaggerations simply intended to get your attention, and which are actually just partisan sales pitches in advice’s clothing.
So what does all this mean for the modern investor? How will all this external pressure and contradictory information affect how we react the next time the market crashes? Will the panic be even greater thanks to more doomsday predictions and close proximity to our last recession? Or will this excess of knowledge and the recent economic recovery be enough to override our natural instinct toward fear, help us understand that these occurrences are inherently cyclical and, most importantly, temporary? During the last financial crisis there were certainly some wise pundits imploring people to see the situation as an investment opportunity rather than a cause for panic. Unfortunately, they were outnumbered around ten to one by provocative talking heads intent only on scaring people and generating controversial headlines.
In the end, the most important thing to remember is that we have been through this before, over and over. There are always going to be periods in time when markets drop at uncomfortable speeds to less than ideal levels, but they always come back up eventually and, over the long haul, always trend upward. Therefore, with these historical certainties in mind, the best strategy is to remain calm, wait for the recovery, and possibly even recognize the situation for the terrific buying opportunity it usually is. As financial advisors it is our job to make sure our clients base their decisions on fact and solid long-term strategies rather than emotion. The ultimate goal is for us to work together as a team to manage fear and eliminate it from the equation.