Mental mayhem can lead to money mayhem
Successful investing requires a calm mind more than anything else.
“With my mind on my money, and my money on my mind.”
Snoop Dogg’s iconic lyrics to Gin & Juice, released 26 years ago, echo a key element of behavioural finance, namely that your state of mind can have a massive effect on your money choices.
“The connection between stress and money may seem self-evident: reduced income, job insecurity and high debt is a recipe for anxiety,” says Sharon Moller, financial planning coach at Old Mutual Wealth. “But emerging brain science research proves that stress also causes you to make impulsive, high-risk decisions about your finances.”
She says this increases your anxiety levels and compromises both your mental and physical health, creating a “chicken or egg” scenario.
“In situations of extreme uncertainty, these impulses, unchecked, can for example result in you selling your blue-chip shares at an all-time low or overexposing your portfolio to a single asset class because of perceived scarcity,” says Moller.
New York Times columnist, certified financial planner and author of The Behavior
Gap, Carl Richards, says often the difference between the higher potential returns of an investment and the actual earned returns can be chalked up to investor behaviour.
In a nutshell, if you let your emotions take over and move your money around in kneejerk responses, you usually end up earning lower returns.
Why stress leads to poor choices
In 2017, neuroscientists for the Massachusetts Institute of Technology found that ongoing stress causes a specific brain circuit used in cost-benefit decision-making to malfunction, making you prone to impulsive actions. Their findings show that chronic stress impacts your ability to think strategically.
Moller explains that uncertainty about your financial well-being triggers the part of your brain primarily concerned with survival – also known as the limbic system. At this point, stress hormones such as adrenalin and cortisol flood your limbic system, pushing it into overdrive. This in turn saps the energy that would usually feed the prefrontal cortex – the part of the brain that weighs up information to make choices in a logical, systematic way.
Chantal Marx, head of research at FNB Wealth and Investments, says the short cuts your brain takes when making investment decisions are termed cognitive biases and the fact that you let your feelings dictate your decision-making is called emotional bias. “Making emotional decisions is not always bad. However, these decisions are not scientific and so the success of these choices will vary,” she says.
In the current environment, investors may be prone to what Marx terms “self-control bias”. This is when you deviate from your investment plans by making erratic buying and selling decisions without taking the underlying fundamentals of the investment into account.
The Schroders Global Investor Study 2020, a survey of more than 22 000 investors around the globe, shows that 78% of investors made changes to their investment portfolios when stock markets experienced volatility in February and March this year. Of those, over a quarter moved significant portions of their portfolio to lower-risk investments.
What you can do
The biggest step in dealing with behavioural finance is becoming aware of your stress reactions and your biases. You need to realise that the market movements do not necessarily refer to your investments. If you simply leave your investments alone, your longterm returns will be unaffected by short- to medium-term market dips.
Marcus Quierin, chief executive and behavioural finance expert at Oxford Risk, says the most ancient advice still holds true.
“Focus on what you can control. You cannot move the market or predict when it is at the ‘bottom’ or the ‘top’. You can postpone discretionary spending and use tumultuous times as an opportunity to take stock of your long-term financial plans. And you can control the opportunity to benefit from the ‘risk premium’ – the long-term reward for owning shares that have eventually weathered every short-term storm yet,” he concludes.