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What roles do hope and fear play in times of financial crisis?

Like flip sides of a coin, hope and fear both turn up when things are uncertain. Dr. Meir Statman provides insights on how to channel those feelings when it comes time to keeping financial perspective.

Transcript

Tim Maurer:
Hello, and thank you for tuning in to Ask Buckingham, an ongoing video podcast series where we invite thought leaders across many disciplines in wealth management to respond to your timely questions with timeless answers. My name is Tim Maurer, and I have the privilege of hosting these short discussions as the director of advisor development for Buckingham Wealth Partners. And I want you to know that I’m also a wealth advisor with more than 20 years of experience and a client of the firm.

Tim Maurer:
The volume of information coming at us these days is so vast, and the pace at which that information arrives is so fast that it’s a struggle to keep up with what you need to know in order to make the best decisions for you and your family. Our hope, therefore, is that this ongoing conversation will become a source of clarity in the midst of confusion and chaos, and provide insight that helps you better understand what’s going on in the world, financially and otherwise.

Tim Maurer:
Today, we’ll be hearing from Dr. Meir Statman, a consultant to Buckingham and the Glenn Klimek professor of finance at Santa Clara University, and one of the world’s foremost authorities in the field of behavioral finance. And here’s the question we’ll be tackling. Dr. Statman, how do the normal emotions of hope and fear play such a meaningful role in life and investing in times of crisis like the one that we’re facing?

Dr. Meir Statman:
Well, first, it’s important to know that God or evolution planted emotions in us to help us, not to spite us. And so, we have to ask, what is the role of hope? Well, hope gives us the courage to take risks, to look ahead. Hope gives us the courage to persist in the face of setbacks, and so it is really very useful. Fear, similarly, is a painful emotion, unlike hope, but it is useful as well. When the car in front of you in the highway suddenly stopped, you slammed the brakes. That is the action of fear before you figure out whether it is an accident or just a jam or whatever it is. When somebody offers you an investment that will yield 10% per week, fear, I hope, will stop you from taking it. That, again, is a useful function of fear.

Tim Maurer:
Hmm. Yeah, and isn’t it interesting too, Dr. Statman, because it seems to me that in the world of investing, for years and years, it’s almost as if people have been talking about emotions as the enemies of good investing. They can be problematic but what you’re saying is, they’re also natural and can be very useful.

Dr. Meir Statman:
Exactly. They are very useful. And besides, you really cannot shut down emotions and so-

Tim Maurer:
Right, you can’t do it.

Dr. Meir Statman:
Pay no attention to emotions when you invest. Well, that is useless piece of advice. What you can do is step back from your emotions and examine them with cognition, with reason, and ask yourself whether this fear is justified or whether this hope is realistic.

Tim Maurer:
Sure. Then what happens when these two emotions, hope and fear, kind of compound or amplify into exuberance and panic?

Dr. Meir Statman:
Well, exactly. So, emotions can be exaggerated and so, hope can be transformed, exaggerated into exuberance. Exuberance then drives you to make choices that are unwise. This is what you do when you just pile on stocks after they have gone up. This is that famous tendency of investors to buy high and sell low. Conversely, fear can turn into panic, where it is exaggerated and where you, for example, in the case of investments, you feel like you must get out of stocks now, sell them all right now. And again, this kind of decision is likely to be one that you’re going to regret.

Tim Maurer:
So, Dr. Statman, how can we best apply this knowledge, this information, and better understanding ourselves with hope and fear and how can we apply that in better, smarter investing?

Dr. Meir Statman:
It is important to know that investment finance is a science. It’s not a philosophy. It’s not that I have a philosophy of investing. I have science, and science relies on logic, and it relies on evidence. And what we know from science is that markets do go up and go down. It is not the case that they always go up after they have come up, and go down after they have gone down. People tend to think this way. This is a cognitive error that we know by the name of representativeness, that is, judging by similarity. And so, when we look at the market today, what is it similar to? It is similar to a wild beast that is sure to go down. So, people tend to extrapolate from that. And of course, panic is accompanying it and people sometimes act in rash and make decisions that are unwise.

Tim Maurer:
Yeah. So, is it helpful to acknowledge emotions? I mean, initially, it’s a feeling, right? But then when it rises to the level of rationale, is it helpful to acknowledge that we’re experiencing a particular emotion at a time like this?

Dr. Meir Statman:
It is very important to acknowledge emotions and it is very important to know and to acknowledge that emotions are normal and generally useful. At the same time, it is important to acknowledge and know that emotions can become exaggerated, that hope can turn into exuberance and fear into panic, and learn to really have that conversation between emotion and reason, and be able to step away from our emotions and examine them, and ask ourselves whether we should do what we are about to do. What is really useful here is to develop habits. If you have a habit that says, when the market goes up big or goes down big, the rule is, do nothing.

Tim Maurer:
Right.

Dr. Meir Statman:
If you follow that kind of habit, that kind of rule, it is going to be easier for you to really set aside or step away from your emotions, so that you do not act in ways that you are likely to regret.

Tim Maurer:
And then, do we have a tendency, Dr. Statman, to have almost a bias to action? Isn’t it almost like we want to feel like we can do something at a time like this where we seem to lack so much control?

Dr. Meir Statman:
That is right, yeah. Control, of course is, and that feeling of control is really very, very important. But I think that it is important to remember the words of the serenity prayer, of changing what you can change and learning to live with what you cannot change, and knowing the difference. And so, again, when the car in front of you in the highway stops, you slam the brake. That is action and that is good action. When the stock market goes down, then you feel like slamming the brakes, in the sense of just getting out of your stock investments. That is going to be one where it is exaggerated fear and you should stop doing that. And remember that you have a diversified portfolio. Your portfolio is not composed of 100% in stocks. There are bonds and other investments, including very short-term bonds and so, not all of it is gone down and not all of it, if it’s gone down, it is not by the same amount. And so, sometimes just sitting tight is better than action.

Tim Maurer:
Excellent advice, Dr. Statman. Step one, acknowledge our emotions. Step two, only control what we can. Thank you very much, and thank you for tuning in to this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, AskBuckingham.com or by emailing your question to question@AskBuckingham.com, or if you want to go the easy way, just click on the screen right now and it will take you to that page. There are no dumb questions, but unfortunately, there are plenty of poor answers out there. Our hope is that in giving you straight answers to your questions, you’ll be able to apply that knowledge in pursuit of good decision-making. So, please, follow us. And by all means, Ask Buckingham.

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