You only benefit from a long-term plan if you stick to it.
Fund flows and behavioural research confirms that we don’t.
We are hardwired to feel that we should act when we experience stress. Market volatility causes us to make decisions that hurt us in the long-term. It impairs your ability to think or behave the way you want to. Emotionally something feels right in that moment even when it has been proven to be the wrong choice in the long run.
We know that we will be tempted into wrong behaviour when it matters most and that reacting to that impulse has historically come with a long-term cost. We are tempted into action when the opposite response – inaction – often proves to be the wiser choice. But staying the course is extremely difficult to do amidst incessant news flow and headlines.
How do we prevent our intuitions to lead us astray?
We can learn from Homer’s epic Greek poem The Odyssey. Ulysses and his crew knew that they would have to navigate their ship past the sirens on the way to their destination. They also knew that the sirens produce an irresistible song that is so beguiling that, when heard lead men to their inevitable deaths.
Ulysses had a plan. His “present self” entered into a pact with his crew to protect his “future self”. He instructed his crew to fill their ears with wax to avoid temptation and had himself tied to the mast to avoid action. The crew, at Ulysses’ behest, would ignore his begging to be set free. And so, Ulysses became the first man to hear the sirens songs and survive.
The essence of the strategy was that, for a predetermined set of conditions, the crew would act in a particular way with the full prior consent of their captain.
Commitment Device
In psychology this is referred to as a commitment device. People are not unaware of the challenges associated with achieving their goals: many take steps to pre-commit their “future selves” to follow-through. A commitment device is a way to lock oneself into following a plan of action that one might not want to do, but which one knows is good for oneself.
Investors find themselves in a similar situation.
From the outset we know that markets don’t provide returns in an upward straight line. We know that the market naturally moves in cycles – both up and down. We know that you can only harvest the market’s return if you stay invested for the long-term through these cycles. And we know that we will find it very difficult to stay invested when the markets go down.
Most of us have long-term objectives best facilitated by doing less, yet the constant noise and narratives of markets are there to lure us into frequent poor decisions. This sounds easy but is evidentially hard to do when we behaviourally prefer action over inaction.
Time + inaction = Good Outcome
A critical part of managing our behaviour is understanding what we are up against and planning in advance how to mitigate this. Commit to a disciplined process in advance that will make action more difficult than inaction.
Sensible decisions at the start of the journey relies on avoiding bad decisions later.
Reacting intuitively to red-hot market news flows leads to poor outcomes. You need to “tie yourself to the mast” or at least slow yourself down long enough to allow yourself to respond rationally when it feels like the world is imploding around you.
Making changes to your portfolio should be rooted in something more objective than your emotions. It must be supported by a system that relies on historical evidence and logic. This is called evidence-based investing. This understanding will help you to make smart decisions about your future.
We need to commit to a process in advance that are based on what we know to be true about what works in the long run. Market volatility will always sow the seeds of doubt that we need to overcome.
The advisors value is most evident in turbulent times.
Any long-term plan that did not anticipate markets to ebb-and-flow was flawed from the outset. Living through a market correction is very different to anticipating how you think you will respond to it. Investors must be educated in advance. Investors need to be committed to a process of planning based on a realistic understanding of the journey ahead.
Helping a client to stay committed to their long-term plan, when it matters, is the most valuable “alpha” that an advisor can add.
“Research is pretty unequivocal that the greatest value that an advisor has is that he or she keeps you from making a handful of bad decisions over the course of your investment lifetime and keeps you in your seat.” – Daniel Crosby
When dealing with the human condition you want to maximise anxiety- adjusted returns that acknowledges that we are not always rational under conditions of uncertainty.
Investors benefit most from a thoughtful and rigorous rules-based investment approach that has been clearly articulated from the outset, that they can commit to and to which their advisor that can hold them accountable to.
Our behaviour and choices determine our long-term outcomes. There is an increased shift in focus from the asset side of financial planning to the human side.
The value of good advice is in closing the proverbial “behaviour gap”.
The above article was written by Marius Kilian.
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