In financial decisions, the two most common steps to look out for are Emotions and Information asymmetry. These are precisely the reasons that for the majority of people, there is a need to have a financial advisor for facts-driven decision making.
Doctors have a very difficult job – to have a driving passion to cure their patients, to be compassionate, while keeping an emotional distance to be able to determine the right course of treatment.
The right treatment goes beyond being able to sift through data (symptoms and reports), to be able to understand that each person is different, and would react differently. A good doctor also continuously updates their knowledge base, to be able to do the very best for their patient.
We all have, at some point, had the urge to do “self-diagnosis”, especially with the advent of Internet search sites. As often as not, the “disease” identified is most often found to be wrong on visiting the doctor eventually.
The above situation indicates a clear-cut example of two things:
1) that DIY (Do-it-yourself) is not always the best course of action and,
2) Emotions affect judgment.
Similarly, in financial decisions, the two most common steps to look out for are Emotions and Information asymmetry. These are precisely the reasons that for the majority of people, there is a need to have a financial advisor for facts-driven decision making.
Emotions: Investors may have the case of FOMO
The two emotions that always compete in investment decisions are Greed and Fear. In reality, it is only one – Fear. It’s either FOMO (Fear of Missing Out) or the fear of losing something. One leads to making a decision when times are good and gives investors more confidence in their ability, their risk tolerance, and knowledge about their needs. Whereas, the other freezes us, or makes us take decisions in haste looking at short term rather than longer horizons.
An advisor understands the need to first put in a framework of making decisions and follow the set process.
Advisors use their own tools for determining Risk assessment, as well as to make a financial plan by understanding the cash flows that an investor has. These crucial steps help in all future communication, the times when the market is performing great as well as in times of extreme stress (volatility) in the market.
They act as a “mentor” to help their investor not get swayed by the “noise” that too much news flow invariably results in. They help to focus on the plan of action, which was made with a rational thought process, each time emotion tends to drive a decision.
Knowledge asymmetry can lead to making the wrong decision
News is mistaken as information. A surfeit of news actually creates a noise that cannot be cut through, and in the worst instance, actually drives to make investment decisions that are detrimental.
It is difficult to sift through data on a continuous basis, to find out what’s affecting our financial goals, to make course corrections, to learn from others unless it is our full-time job. Let us not forget the years it takes – of training, and on the job experience, that a fund manager has before he is actually in a position to make decisions.
These fund managers can effectively identify not only opportunities that help achieve their investor goals better, but also analyze data that is relevant to their client’s portfolio, and convert them into actionable insights.
The Role of an Advisor
Advisors play a crucial role in times of extreme stress as they provide a comprehensive update on their client portfolio at a higher frequency. To reiterate the goals based on which the investor had made their portfolio. Re-evaluate the plan due to the changed circumstances, not only of the market but also of their clients – job losses/salary cuts. They help their client re-look at the adequacy of their Health Insurance which is often missed out in the DIY method. To find means to lower costs – e.g., can their Housing loans be shifted to a more economical provider. This is also the time they would look at new opportunities – because let us not forget, a crisis also reveals opportunities. For e.g., streaming entertainment services, like Netflix.
All this can be done because advisors are well-versed with the ecosystem, with up-to-date information and correct predictive analysis, which enables them to customize the solution as per their investor’s financial goals. Financial advisors have also gone through such volatility in more frequency than a personal investor, which allows the former to make decisions without letting emotions, their own as well as that of their clients, overcome the process.
Redefining Risk management
DIY investors tend to perceive risk management as avoiding losses. In reality, risk management is about taking chances while mitigating potential negative fallout with safer bets: it’s about maintaining an acceptable level of risk to enable higher returns. Part of this process is also reviewing investments. To not be swayed by personal bias, hindsight bias, or being too attached to them. This helps in identifying losers and pruning them, to make way for the new potential winners.
While DIY investing is a good first step for Millennials keen on getting into the market, experts are needed to build a long sturdy profile. In times like these where uncertainty is the norm, expert advice can bring the difference between making it through the crisis with a stronger portfolio and suffering losses over the long term, when things turn back to normal.
In order to gain from the current scenario, the best way is to adopt a strategic, long-term position, investing in segments that will play a key role in rebuilding the world in the months and years to come. Professional advisors can direct DIY investors towards the segments to look out for and the ones to avoid.
by, George Mitra, Co-founder, CEO of Fintso