Loss Aversion Revisited: Brains Scans & Practical Solutions
15 Mar 2017
We often get the question “What will the stock market do?” during our radio shows Tuesday nights on WMT 600AM and WHO 1040AM. Our company president, Jeff Johnston, often says “I don’t know what the stock market is going to do, but I know how most people will react to what the stock market does.” This statement always reminds me of a due diligence trip I took to Laguna Beach, CA several years ago. In a room full of over 100 investment advisors, like myself, the speaker representing the investment company put up an x-ray of a human brain. He said, “Take a look at this real life brain scan of a guy who just won a lot of money! The natural chemicals are gushing through his brain, and your clients could be like this guy.”
I thought to myself, “Forget that… I want to see the brain scans of the employees that lost an average of 42% in their 401(k)s during 2008*.” I got back to Iowa and while doing research looking for ‘the other brain scan’, I stumbled upon what I believe is one of the best TV series on behavioral finance I have ever seen: “Your Mind and Your Money” and NBR/PBS series. There it was, in the second episode, the brain scan of a person that just lost money. It just so happens it look identical to the scan of the guy that just won money.
So what are some practical solutions for investors who feel like they are losing money? The answer depends on what stage of investing you are in. At Premier Investments we determine that investors are in 1 of 2 phases of their financial life:
Phase 1: Accumulation
Investors in this stage are focused on accumulating assets. Investors in this stage shouldn’t focus too heavily on the value of their accounts, but rather the number of shares they own. Focus on your portfolio allocation to make sure you are diversified.
Phase 2: Distribution
Investors in this stage are making the transition from accumulating assets to turning those assets into income to live off of in retirement. Investors in this stage should focus on their portfolio allocation and make sure their investments are returning the income they need in retirement.
Remember, you haven’t really lost money until you sell the investment and realize those losses. I hope these tips help investors, so they don’t need a brain scan to tell them how they feel about investing.
*Source: MetLife Retirement Income Study
**Asset allocation and diversification do not assure profit or protect against loss.