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How to keep your head when markets are tumbling

Steve Wendel  |  10 Nov 2016Text size  Decrease  Increase  |  

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Focusing on the negatives won't help you as an investor, says behavioural scientist Steve Wendel. Instead, stick to your personal investing strategy.


I didn't get much sleep the other night. Regardless of politics, I couldn't help thinking about the crash that was already looming when I switched off the computer at midnight last night. What that meant for my family, and what it meant for our retirement goals.

I'm a behavioural scientist and a valuation-driven investor, and I can easily rattle off some of the behavioural biases that were at work.

Vividness bias: I could not help but fixate on dire market scenarios. What havoc would a trade war wreak?

Recency bias: I could not help but forecast how the midnight drop in the futures market was going to extend into a terrible rout.

Herding effect: I thought of all of the people around the world who were rushing to safety, and I got that anxiety that bubbles under the skin.

Fixating, forecasting, feeling anxiety. It does not matter that I'm a behavioural scientist--they still threaten to overtake me.

As a valuation-driven investor, it's also easy to rattle off what that moment meant as a profit opportunity. But at the moment it's too real, too immediate.

I knew I couldn't simply ignore the turmoil--both inside and out. If I tried to, there was a good chance that I'd make things worse. I knew I could fight off the desire to panic, and I could do it for a while to come.

But eventually, if the market really does start to tumble, then I might waver. Our willpower is finite, and we all have our off moments. When things get really dark, I might finally decide that it's too much for me.

How to control your emotions when investing

I'm sure you've heard stories of stalwart investors who made that fatal mistake--they thought they could ride out the storm, only to jump overboard at exactly the wrong moment.

I'm not foolish enough to think I'm somehow magically smarter and stronger than all of them--supporting my own ego is not worth the financial risk.

So instead, I am "externalizing"--focusing on how I can use triggers outside of my emotions to guide me. It's a common theme in behavioural science on how people can make better decisions.

Right now, I'm bringing up my "personal investing strategy" that I wrote for myself a while back. It's dull and systematic; an external reminder of the calmer mindset I was in when I put my money in the market in the first place.

I am reading over the commitment I made: I can't directly change my investments. I can't buy or sell. I can only follow my investing strategy or, after a cooling off period, change the strategy.

My strategy's rules decide when to buy and sell. It's an external abstraction that insulates me from the rush to take action.

I am adding friction to my path, including by requiring that my wife has to sign off on any sale.

I am also going into the office at Morningstar the next few days and talking to people about what this means for investing. They know I'm a valuation driven investor, and many of them are as well, and I'm using the power of my community of investors to keep me on track.

At the moment, I don't have an adviser; if you do, that's another powerful way to externalise--creating friction on the path to rash action, and adding a calmer voice to remind you of your values and goals.

Each of these approaches to externalising decision-making, and how they can make us do better in anxious, fearful times, has a body of research literature behind it.

I know there's no guarantee we'll make the right choices even with these techniques. But, from what I've seen, these approaches could help.

The markets are just one part of the momentous changes that are occurring right now in the United States, and likely the world. But, unlike world events, we have direct control over how we act in the markets, right now.

We cannot ignore our emotions. But, we can sidestep them, and find ways to create external reminders and rules, external frictions, and peer pressure to help us keep our heads.

More from Morningstar

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• US election 2016: Sit tight, whatever the outcome


Steve Wendel is head of behavioural sciences for Morningstar.

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