The Covid-19 crisis has shown us that humans hate uncertainty, and our brains rely on past experiences to try and create a more predictable world.<\/p>\n
\u201cThese two interconnected neuroscientific realisations are very important from an investment perspective,\u201d said Paul Nixon, head of technical marketing and behavioural finance at Momentum Investments.<\/p>\n
\u201cDuring times of high uncertainty, like we are experiencing now with Covid-19 and the extended nationwide lockdown, people are more predisposed to use their gut instincts and put critical thinking on the backburner. This puts us at risk of making decisions that could sabotage the success of our financial future.\u201d<\/p>\n
Nixon said that the human brain has a rule book to make the world more predictable.<\/p>\n
\u201cThis rule book is essentially a belief system about how the world works. However, sometimes our brain will convince us of something that isn\u2019t true, which is the essence of a cognitive distortion. This is because the brain is not necessarily looking for truth; it is looking for meaning,\u201d said Nixon.<\/p>\n
\u201cArising from past interactions with assumptions about the world, \u2018unconscious inferences\u2019 can lead to a visual precept that appears to differ from reality. Similarly, cognitive distortions stem from heuristics or thinking shortcuts.\u201d<\/p>\n
Applying this concept to an investment or advice scenario, Nixon said that, depending on what experiences and information clients have been exposed to in the past, they would have formulated belief systems around investing.<\/p>\n
\u201cSome of these belief systems may very well be false, such as the common misconception that past investment returns are a great way to select future investments.<\/p>\n
\u201cThese belief systems are going to inform their investment choices going forward, but ultimately, when they don\u2019t get the results that they desire, their willpower to stay invested for the long term will be tested.<\/p>\n
“This only perpetuates the cycle, because clients will then start looking again for other investments options that have performed well in the past, switching course from their original plan.<\/p>\n
“Unfortunately, even if proven unsuccessful, a belief system that has been developed based on past experiences is very difficult to change,\u201d the behavioural finance lead said.<\/p>\n
\u201cAs financial services providers, we are going to have to arm financial advisers with tools and diagnostic techniques that enable them to have the right conversations with clients around the psychological dimensions of financial planning.\u201d<\/p>\n
He also highlighted that \u201cbehaviour tax\u201d is at its highest during times of extreme market uncertainty.<\/p>\n
\u201cA behaviour tax is the difference between the return an investor would have received if they\u2019d stuck to their original plan, and the return they actually received as a result of their switching activity,” Nixon said.<\/p>\n
Despite the heightened uncertainty Covid-19 has caused, Nixon emphasised that, as long as clients\u2019 investment goals haven\u2019t changed, their plans to reaching these goals should not be changing either. \u201cThe biggest cognitive distortion out there for investors right now is the market turbulence trap,” he said.<\/p>\n
“When we look at our long-term investment goals through a short-term lens, we get the illusion of a lot more volatility and uncertainty.<\/p>\n
\u201cPeople have very short memories and, in a year or two, most will have completely forgotten how they were feeling during this time of uncertainty. In this sense, what remains most important now is protecting clients against cognitive distortions and keeping them invested in terms of their long-term goals,\u201d Nixon said.<\/p>\n