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What separates us humans from the animal kingdom is our ability to reason, plan, and think about the future. We humans – unlike the rest of this planet’s sentient beings, for whom the time is always “now” – are forever contemplating what will happen next.
But though these cognitive abilities make us superior to animals, we’re still pretty primitive when it comes to our instinctive sense of danger. In responding to perceived threats, we operate much the same today as we did in the days when we were covered with hair and hunted other beasts.
That instinctive side kept us alive by alerting us to danger quickly. If a sabre-tooth tiger comes after you on the savannah, rationally calculating the distance to the nearest tree would likely be fatal. Instead, our instincts powered us up with adrenaline, and kicked us into “running like a hare” mode – several crucial milliseconds before our cognitive brains could process the situation.
Even in today’s civilized world, those old instincts still kick in when we’re faced with uncertainty of any kind. And for many of us, one of the biggest sources of anxiety is the process of investing. Our two biggest fears might be summarized as: “Good God, I’m losing money right now!” and “Good God, I’m going to end up eating dog food in my retirement!”
Those fears come from separate places in our brain, though, and we need to deal with them in different ways. The fear of not accumulating enough to sustain a reasonable standard of living in retirement is one we handle with the thinking side of the brain. We map out a savings strategy, invest for the long term, and aim for a high rate of return. We recognize inflation as a serious long-term threat, we diversify sensibly, and we buy assets to reduce risk. Those are all rational responses.
But the fear of actually losing your capital is a more primal terror. When something in your portfolio takes a nose-dive, from the pit of your stomach comes the instinctive response: “HELP, I’M LOSING MONEY!”
This instinctive fear is the most common reason investors fail at long-term planning. Their strategy gets compromised because they panic and sell off an investment in decline – just because they want the pain and fear to stop. Statistics abound proving that the average investor, impelled by this primal fear, fails to achieve a rate of return that’s even close to market returns.
The investment industry has to bear some blame for this: it does investors few favours in helping them through the tough times. Since we in the industry are all wired just the same as our clients, we offer the switch to “new” products to protect them against what’s already happened. Oh, and we also offer reassuring reams of proof that declines are temporary, and that everything will be fine in twenty years.
Well, the first strategy (switching to a new product) ensures that investors sell at exactly the wrong time; and the second strategy (offering proof and logic) speaks to exactly the wrong side of the brain.
I’m contemplating fear again, because it’s such a potent topic. On the top of Toronto’s CN Tower, if you stand on the glass floor, you can look straight down 1,464 feet to the ground below. The fact that this thick floor can support the weight of several elephants never stops bystanders from crying out whenever a child steps onto it. This tells us that the fear of falling is not a reasoned response.
Ditto the fear of financial failure: when it comes to your investment portfolio, only logic can help you to recognize whether your fear is real, or whether you’ve just “walked on a glass floor.” A good portfolio will always contain some element that’s not doing quite as well as the rest. The whole concept of “diversification” means that some parts of your portfolio are up but others are down. And taking a measured risk for higher reward means that sometimes an entire portfolio will decline in value.
But diversification and volatility are integral parts of your strategy of getting a good long-term result. It takes a lot of strength to hold onto a portfolio through all the twists and turns of market volatility. Fortunately, market diversity is one of those things that can also support the weight of several elephants – as long as you recognize the fact.
Alan MacDonald is an investment advisor who helps high tech entrepreneurs make smart decisions about money. Contact Alan at Alan.Macdonald@RichardsonGMP.com
Alan MacDonald CFA CFP
Ph: 613-788-8010
Cell: 613-863-5343
Fax: 613-788-8078
343 Preston St. Suite 300
Ottawa, Ontario K1S 1N4
