How to manage and deploy your fear of investing to make it work for you

This is an article about fear of loss and how it can impact your financial plan and achieving your goals.

If we pause to consider what we have experienced in recent times it is no wonder that some people will be driven by fear of what could go wrong. The last 4 years have been quite extraordinary. We have gone through a global pandemic which drove substantial and rapid social and economic changes with lasting impacts on how we live, communicate and interact with each other, in business and personally. As we emerged from that, we experienced the highest burst in inflation the world has seen in more than a generation, with the fastest rise in interest rates in over 40 years. We all experienced this with the higher cost of living. We are now emerging from this period, with inflation returning to normal, and not completely unsurprisingly, in an economic environment that has shown more resilience than expected, avoiding the worst of the prognoses of recessions, generating stable economic growth. At the same time we are enduring the impacts of conflict around the world, notably in Ukraine with the Russian invasion, and the Middle-East.

When you look at the world in this light, it is reasonable to think about what could go wrong. However, decision-making that is overly driven by fear of loss can hold you back and leave you worse off.

We are primed for loss aversion. In an investment context that means when there is negative economic news, or when markets are falling, we place more value on avoiding a loss than we do on making a gain. The problem in investing is that we value avoiding the short term loss and then miss the potential longer term gain.

At this point, it is important to distinguish between risk and volatility. In this context, we define risk as the risk of losing your money in an investment. For example, you invest in an asset, perhaps a share in a company, and that company goes into liquidation, meaning the shares are worthless. Volatility is different. We consider volatility to mean the change in value of an investment from one point in time to another. For example, you invest in a diversified portfolio which is worth €100. Over the next five days its price may be: €100, €101, €98, €97, €102. The value may change, but the investment remains in place. Another example is property, if you receive a valuation every year from your government institution, some years it is deemed to be wroth more or less than the prior year.

Using these definitions, a key way to reduce risk of absolute loss in investments is to diversify what you invest in, i.e, holding a number of assets that can be expected to generate a more consistent aggregate return that is in line with your expectations. This approach can reduce the volatility over time if that is important to you, but will probably not remove it. This is not necessarily bad. There is a direct relationship between volatility and return. Simply, the higher the short term volatility in an investment, the higher the potential return over the longer term.

An important part of providing financial planning and investment advice to our clients, is to understand the optimal level of volatility for each client. Too little and you risk missing potential returns over time. Too much, and your investment might keep you awake at night with worry. It also needs to be refined to make sure you are generating the returns your objectives require. We often describe this as taking on the lowest level of volatility required to achieve your long-term goals. We aim to get this balance right, specifically for your unique situation.

Understanding your comfort level with volatility, and reconciling that with what your goals require, and then applying this to a strategy is part of what we do.

We need to monitor and manage this over time. This includes a focus on communication and education, to make sure our clients understand how these factors work together, and why we make recommendations.  

The manifestation of our hard-wired loss aversion, our fear of loss, can lead us to fall into the traps of momentum and herd investing behaviours. This is most relevant in market downturns. History has taught us that markets have tended to go up and down (volatility) but over time, have increased in value. See the graph below of the US Stock market over the last 50 years. Markets downturns can be stressful in the moment, but reacting to them is not always the best action. It can be difficult to go against following the herd, and the influx of negative news as market falls gain momentum, but looking at the graph suggests that, as long as the time frame of your goals permits, not reacting can make sense.

We maintain that it is time consistently invested in the market that adds real value over time rather than trying to time a market.

We believe the purpose of investing is to achieve your long-term objectives. Investing is a means to an end, not the end in itself. The most important question is not whether there is a short-term need to change, but whether your investment structure and investment plan are still aligned for you to achieve your goals.

While fear is real, and inbuilt for good reason, it is a useful exercise to understand what drives it for you. If you have a fear of investing, because perhaps you, or someone you know may have lost money in the past, the best solution is education to understand how things like market volatility, and investment risk apply to you.

We can help with that.

If you would like more information or to arrange a time to speak with us, contact us at info@extinvestments.com.