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Written by: Amber Williams, Senior Vice President of Client Investment Strategies and Chief Sustainability Officer, Lincoln Financial Group
Recently, I ran into an old colleague who's retired from financial services. We got to talking about some of the newer protection strategies on the market. I was shocked when she sighed and said, “Oh, something like this would have been so helpful back in 2020. I made a really bad decision.”
Like so many investors, my friend had sold a considerable amount of her equity position when the market plunged. She panicked, and then she regretted it.
What to do when clients are screaming, “Get me off this ride!”
The pitfalls of emotional investing are suffered all too frequently as investors ride the famous “Cycle of Investor Emotions,” the fascinating whirlwind of feelings that mirrors the tumultuous journey of a roller coaster. The trip takes investors to the heights of euphoria in good times and plunges them into the depths of panic in tough times.
This emotional cycle is normal, expected, and frankly — as was the case with my friend — hard to manage.
This is why understanding investor psychology and the role emotions play in our money choices is so important. It's a topic my team and I have been discussing quite a bit lately. Specifically, how can we most effectively empower investors to step off the emotional roller coaster and remain steady as they move toward their long-term goals?
The “Invisible Hand” vs. “the voice of human weakness”
In 1776, Adam Smith, the “father of modern economics,” published his famous book The Wealth of Nations, which remains to this day an essential text for understanding the mechanics of the global economy. The Invisible Hand, which assumes rational, self-interested economic players, is one of the most famous concepts from this work.
However, nearly two decades earlier, Smith recognized in A Theory of Moral Sentiments that even the most rational actor can occasionally freak out:
“There are some situations which bear so hard upon human nature that the greatest degree of self-government . . . is not able to stifle, altogether, the voice of human weakness, or reduce the violence of the passions to that pitch of moderation, in which the impartial spectator can entirely enter into them.”
In other words, no matter how disciplined an investor is, there is always the danger that the panicked voice in their head will drown out the voice of reason.
Not to skip over 200 years of economic history — and several thick college textbooks worth of information—but by the mid-1900s though today, much of the science of Economics has focused on crafting optimal investing strategies using rational mathematics.
However, the problem with Modern Portfolio Theory — and much of what is taught in Econ 101 — is that it places too much emphasis on the assumed rational investor behind the Invisible Hand, and not enough emphasis on the fallibility of human emotions and mental shortcuts. But that's starting to change.
Learning to unlock investor's hidden thoughts
Behavioral economics is very old and very new, all at the same time.
It has its roots in the work of two legendary Israeli psychologists, Daniel Kahneman and Amos Tversky. Their research was so interesting and revolutionary, Michael Lewis dedicated an entire book to their story. In a New Yorker article, they are called "the Lennon and McCartney of social science" for their period of “extraordinary creativity” in which they build the foundations of modern behavioral economics.
Tversky was awarded a MacArthur Genius Award, and after his friend's untimely death, Kahneman was awarded the Nobel Prize in Economics. The co-author of the New Yorker article, Richard Thaler (of The University of Chicago), was friends with the duo, and was in turn awarded the Nobel in 2017. The Economist underscored the importance of the developing field:
“For a very long time, economists hoped to treat individuals a bit like particles in physics, whose activity can be described by a few well-understood rules…Then came the behavioral economists, who made it their task to find ways in which human activity systematically diverges from models using those basic assumptions…That new set of principles never really emerged, just a bunch of behavioral oddities.”
To use one of Thaler's favorite analogies, our economic models assumed we would act like Dr. Spock, but the more scientists look at economic behavior, the more they realize investors act like Homer Simpson — or more simply put, humans — much of the time.
Helping clients understand their impulses is a key to success
Emotional reactions are not a bad thing: we are hardwired this way in order to survive. But we need to take the time to understand how emotions play out in the world of abstract investing.
Personally, despite decades of experience and training in portfolio theory, I've now come to accept that even with the most optimized investment strategy, the very traits that make us human — like the desire for security or temptation of greed — are all too often our downfall. And this should be factored into every discussion we have (or don't have) with our clients.
I don't have all the answers, but we've seen over and over, how protecting investor portfolios has led to better client outcomes. These strategies inherently come with a dose of confidence to help clients manage their emotions and stay invested for the long run.
My team and I will continue to work on this topic and provide resources that will help you uncover the forces that may be impacting your client's money choices and strategies to guide them towards making the sound financial decision. More to come!
About the author
Amber Williams is Senior Vice President, Head of Client Investment Strategies and Chief Sustainable Officer for Lincoln Financial Group.
In her role as Head of Client Investment Strategies, she is responsible for providing strategic leadership to achieve key business objectives. She leads a team of talented investment specialists who provide thought leadership, investment expertise, and education to Lincoln’s distribution teams, internal stakeholders, and financial professionals. Since joining Lincoln in 2019, Amber has expanded the team’s reach to support all of Lincoln’s business lines and established a differentiated thought leadership program that maximizes the value of Lincoln’s unique multi-manager platform.
Amber is also Lincoln’s Chief Sustainability Officer. In this role, she is responsible for guiding Lincoln’s Environmental, Social and Governance (ESG) efforts, advocating for and supporting the integration of ESG priorities across business areas and encouraging a sustainability mindset across the enterprise.
Amber holds a B.A. degree in Accounting from University of Phoenix, is a member of the CFA Society of Philadelphia, and holds her Series 6, Series, 7, and Series 24 securities licenses.
To read other blog content like this, visit Lincoln's informed financial professional blog.
Important information
Lincoln Financial is the marketing name for Lincoln National Corporation and insurance company affiliates, including The Lincoln National Life Insurance Company, Fort Wayne, IN, and in New York, Lincoln Life & Annuity Company of New York, Syracuse, NY. Variable products distributed by broker-dealer/affiliate Lincoln Financial Distributors, Inc., Radnor, PA. Securities and investment advisory services may be offered through non-affiliated entities.