Financial markets have been causing stress for investors, and the emotional toll can lead to poor decision-making. So, what can you do to ensure you have the right mindset and tools to make decisions under stress? Financial Adviser James Howard explains ways that may help during these times.
When life throws curveballs
Many events can cause stress in our lives. Problems can arise at work, in relationships, a change in lifestyle, a health issue or simply by being overwhelmed with the pressure of everyday life. During acute and chronic stress, our decision-making is negatively impacted.
However, despite these stressors, life goes on. Decisions — big and small, significant or trivial — must still be made. Unfortunately, stress only worsens your ability to make complex decisions.
What research says about habits
Research studies have shown that heightened stress levels cause our attention to narrow. Humans often focus on irrelevant but readily accessible information when making decisions. For example, in the investing world, factors such as the Familiarity Bias and Recency Effect lead investors to buy more shares of local businesses or companies they have recently seen in media headlines — habits that often result in lower returns.
When media headlines are negative, people tend to feel overwhelmed and adopt a more straightforward approach to information processing, relying heavily on superficial information for making decisions. Stress often takes away the ability to take a step back to look at a situation objectively. Other research1 has shown that the more stress people feel, the more inclined they are to see patterns that don’t exist. Numerous studies support this, which may explain why we tend to see markets continuing to go down during times of volatility, or even housing markets continuing to go up – forcing decisions that may not have been otherwise made. It may also explain why people panic-purchased toilet paper during the lockdown, despite assurances that there were no ongoing supply issues.
The physiological effects of stress
Struggling to remain rational in the face of stress isn’t merely a test of will. Physiological mechanisms at work during acute stress impair our ability to make sound, clear-headed decisions. Once you are aware of the triggers, it becomes something you can be mindful of to put steps in place to manage.
Stress triggers our glands to release elevated cortisol levels, which is part of the fight or flight response. Cortisol can fire us up as we rapidly decide to defend ourselves or flee from a threat. Still, it’s highly counterproductive when rapidly weighing complex odds and making decisions.
Being tired or hungry can affect our judgement significantly. Another interesting study2 investigated the decisions made by parole judges in the United States. While the analysts hoped that variables such as the case’s facts, the crime’s severity, and prior precedents would drive impartial judicial decision-making, they were surprised to find that the single most highly correlated factor with the decision was the time of day. At the beginning of the day and after a break, parolees received a favourable ruling about 65 per cent of the time. However, the percentage of prisoners granted parole fell to zero in the hour or so before lunch and before the afternoon break.
Tired and hungry judges didn’t have the mental stamina to deliberate rationally, so they made the most energy-efficient decision possible – no to everything. It’s not hard to conceive what the investment parallels might be.
In times of stress, learn to HALT
In his book The Behavioural Investor3, behavioural finance guru Daniel Crosby gives readers an excellent acronym for how investors should handle moments of acute stress.
When making any investment decision, an investor should first try to assess their emotional state, and if they are feeling Hungry, Angry, Lonely, or Tired, they should HALT and not make any investment decisions in the spur of the moment. Walk away, get some space, rest, time, and perspective before returning to the decision with a clear head once the emotional state has passed. Emotions are chemical reactions; letting them pass can fix a good deal of problems.
This is a great approach to apply to decision-making in general during times of stress. How often have you sent an email in the spur of the moment or said something negative to a colleague or loved one just because you were stressed?
Following Daniel’s advice, the key is to recognise the emotion, acknowledge it, and allow yourself to experience it. We are emotional beings; there is no shame in that! The key takeaway is don’t make any decisions in the heat of the moment.
Ways to avoid making the wrong investment decisions
Whether you manage your investments, buy a house, or deal with family or relationship issues, developing a plan is key to making good decisions. Writing things down is always a great way to think before you act and outline the steps you will follow. It may seem like common sense, but it is something that is rarely done.
As Financial Advisers, we spend considerable time with clients at the beginning of our relationship to develop a financial plan which helps in the following ways:
- Setting clear goals for the future: Ensures you are working towards something meaningful and brings the focus back to what matters during times of stress.
- Having the right investment strategy: This will align with your goals, cash requirements, and investment time horizon and mean you are never in a position where you are making a significant financial decision under stress.
- Planning: If you have cash requirements, planning well in advance gives you the confidence to focus on dealing with stress instead of adding to it. Planning also prepares you to manage market volatility, emotional volatility, and subsequent decision-making. It ensures you have a clear decision-making framework when experiencing times that are not so clear.
One of the most important things is to be at peace with your decisions based on your plan. You can often get caught up wanting to make the right choice but are too reluctant to make any decision. This usually means you never start the journey to where you want to go or quit too early on. Developing a plan sets out a clear pathway for success and ensures you stay focused on the things that matter along the way.
If you have any questions about investment decision-making, talk to a Financial Adviser who is trained to listen and guide you through times of stress and investment volatility.
13 September 2022
2 Extraneous factors in judicial decisions, Shai Danziger, Jonathan Levav and Liora Avnaim-Pesso Authors Info & Affiliations – Edited by Daniel Kahneman, Princeton University, Princeton, NJ, and approved February 25, 2011 (received for review December 8, 2010), April 11, 2011, 108 (17) 6889-6892, https://doi.org/10.1073/pnas.10180331
3 The Behavioral Investor, Daniel Crosby, Published October 16th 2018
Disclaimer: This article is general information and does not consider your financial situation or goals and does not constitute personalised advice. There are no warranties, expressed or implied, regarding the accuracy or completeness of any information included as part of this article.