My first money memory really set the tone for my approach to investing throughout my life. At just twelve years old, after years of squirreling away birthday and Christmas cash into my piggy bank I had finally managed to save a grand total of $800. A sum worthy of a trip to the bank!
My mother brought me to our local branch, where the kind financial planner praised me for my saving discipline. Distracted by a wave of self-satisfaction, before I knew (and to my horror) it I had exchanged my money for an impressive looking piece of paper – a savings bond that would lock my investment away for ten long years. I walked in with my life’s savings, and walked out stunned.
I took away a big lesson from this experience: saving money takes time and discipline, so there’s absolutely no room for risk when it comes to your investments.
Like me, many people are risk averse when it comes to their finances and have a fear of losing their hard-earned life’s savings when the markets dip. And for many of us, this fear can be detrimental to our long-term financial success.
Fear is inevitable, so how do you keep it from holding you back?
I asked psychologist, behavioral finance expert and Executive Director at The Center for Outcomes, Dr. Daniel Crosby, to help explain how fear can negatively impact my potential for financial success and what I can do to overcome it.
“Worrying about your money is a “when” and not an “if” question regardless of who your parents are. Success is about preparation, not heredity.”
But before we got too far, I needed to know if the fact that I’m a risk-averse worrier by nature meant that I was genetically doomed from the start. So I was relieved to find out that Dr. Crosby believes there’s hope for me yet!
“The fact is that everyone, regardless of biological susceptibility, starts to worry when markets get as volatile as they have been lately. The key is less about winning the genetic lottery and more about having practical measures in place that keep you from doing things that are inconsistent with your plan when the market gets choppy. Worrying about your money is a “when” and not an “if” question regardless of who your parents are. Success is about preparation, not heredity.”
With those reassuring words in mind, the first step to overcoming financial fears is to understand how our emotions affect the decisions that we make.
According to Crosby, “fear impedes our ability to think clearly and access the great lessons we’ve learned from say, our financial advisor. Studies have shown that we lose 13% of intellectual processing capacity when we are under duress1, meaning that people have the least access to their knowledge at the very moment they need it most.”
And unfortunately, there’s no quick fix because everyone’s fears are different.
“Fears are as varied as the people who experience them and they tend to assume the shape of whatever matters to us most,” says Crosby.
In Personal Benchmark, a book co-authored by Dr. Crosby and Chuck Widger, they explore over 100 ways in which psychologists have identified that investors make fearful, maladaptive and irrational decisions.
“It may seem counterintuitive, but your advisor’s primary value is as a behavioral coach and their secondary value is as a money manager.”
“We then took that universe and distilled it down into three common traits that underlie each of those behaviors – simplicity, safety and surety,” Crosby explains. “The key to managing bad behavior is to meet your needs for simplicity, safety and surety in ways that enhance your wealth instead of sacrificing long-term gains for the sake of short-term emotional comfort.”
So for example, I have a fear of investing because every time I turn on the news, I’m told that the stock market is unstable, the economy is floundering and something is happening with the price of oil. It’s overwhelming!
In response, I look for simplicity, which Crosby explains is the very human need to take all of the financial noise out there and distill it down into something meaningful and actionable in our lives. And we do the same thing when it comes to our desire for safety and surety.
“Some people seek this simplicity by taking stock tips from a neighbor and others do so by getting a comprehensive financial plan from a professional,” says Crosby. “Both are forms of simplification but one is far superior to the other.”
In a perfect world, investors could simplify things by taking their emotions out of the equation and manage their money based on probability alone. But fear negatively skews our sense of what is probable, so aren’t we right back to where we started?
“Investors who get it right do a few things very consistently: they diversify across asset classes, they exercise patience, they take a long-term view and they work with a financial advisor to help them keep their emotions in check,” says Crosby.
Ah-ha! So the key to success seems to be to bring in a heavy hitter – a financial advisor you trust and respect who isn’t emotionally attached to your investments.
“Research by firms as diverse as Morningstar, Aon Hewitt and Vanguard has shown that there is a 2 to 3% annual outperformance experienced by those who receive sound financial advice,” says Crosby.2
“Surprisingly, this outperformance is primarily driven by hand holding and not money management. It may seem counterintuitive, but your advisor’s primary value is as a behavioral coach and their secondary value is as a money manager.”
In hindsight, this doesn’t surprise me given the number of times my meetings with my financial planner have turned into borderline therapy sessions.
“One strategy is to engage in what psychologists refer to as pre-commitment: agreeing with your advisor in a time of clear-eyed rationality what you will do when things get scary.”
After all, I have the capacity to improve my financial literacy and investment knowledge simply by Googling any concept or question, but when the time comes to actually take action fear and doubt always seem to set in.
So when I start to panic in my financial advisor’s office, how do I regroup and stay on track?
“One strategy is to engage in what psychologists refer to as pre-commitment: agreeing with your advisor in a time of clear-eyed rationality what you will do when things get scary,” says Crosby. “The trick with pre-commitment is to make it hard to take an action (e.g., selling everything) that would go against the plan.”
And part of successful financial planning is about embracing our fears and risk tolerances, rather than working against them. In their book, Crosby and Widger coin the term “personal benchmark” which touches on just that.
“Instead of benchmarking your performance to arbitrary metrics like the S&P that have nothing to do with your risk tolerance or return needs, determine the risk and return tradeoffs you are willing to make to live the life of your dreams. Then benchmark to that,” says Crosby. “When stocks start to fall, everything inside you will be screaming, “no!” The only way you can counteract that is to be working toward a bigger “yes!”
Armed with these insightful strategies, I think it’s finally time for me to put my oracle away and face my finance fears. My savings bond has long-since matured (nope, I never cashed it out!), and I think it would be a very full-circle experience to reinvest it into an asset that albeit riskier, has greater potential of getting me to my bigger ‘yes’.
1. Widger, C., & Crosby, D. (2014). Personal Benchmark. Hoboken: Wiley.
2. FI Guide, January 20113, LON Jefferies, Retrieved from: http://www.figuide.com/is-working-with-a-financial-advisor-worth-it.html