The emotional investment rollercoaster

You can also listen to this podcast on iono.fm here.

SIMON BROWN: I’o chatting with Paul Nixon, head of behavioural finance at Momentum Investments. Paul, I appreciate the time today. In a recent note put out by yourselves you made the point that you’ve done extensive research during the Covid-19 pandemic, and you’ve discovered that clients suffered losses of some R600 million owing to frequent switching between funds. Again, it was a scary time, but that number just absolutely boggles my brain because it has quantified what our emotional state can do to our long-term investments.

PAUL NIXON: Absolutely, Simon. Thanks for having me. We’ve starting to track a lot of this stuff at Momentum Investments being the kind of cost of people’s emotional decisions during both up and down markets, and in fact normal market conditions as well. We call that a ‘behaviour tax’. It’s a behaviour tax simply because we track if someone was invested in any particular fund and moved to another one.

For example, [from] the time of Covid we continue to track what they moved from, and then obviously at the end of the year, if those two numbers are different, if what they’ve moved to performed worse, then they incur a behaviour tax.

So the interesting thing about this is that I think from an industry perspective we’re starting to see more and more firms using things like machine learning, and indeed advanced predictive analytics and AI to help them really get to grips with what investors are costing themselves; and to help financial advisors as well [to] help their clients make better decisions.

SIMON BROWN: Well, I want to come to that in a moment, but you mentioned that it’s both fear and greed. During the pandemic the market was collapsing, and in truth it was scary. It was the first pandemic in a hundred years. We were locked down. After that it was the Fomo [fear of missing out]; it was AI, tech, crypto, whatever the latest meme stock was. It’s hard, I suppose, to look out at that and do nothing – but do nothing is almost always the right response.

PAUL NIXON: Indeed. So if you think about it, there are cases where moving from one investment to another is a good idea. That’s not all bad. So if your goals are changing, for example as an investor, if you’re thinking for example that your children are going to go overseas and you’re thinking of emigrating or whatever, if your goals change dramatically like that, of course there might be a very strong case for you to make a switch decision.

But the problem is really when emotion is driving that switch decision. That’s generally when you’re making the wrong choice. And in many cases, as you’ve already mentioned, the best case is often to do nothing – which is the most difficult thing to do.

So what we end up doing as investors in those moments is we trade off future investment returns for current emotional comfort. It makes us feel better to do stuff, but that is costing us money. That’s really why we’re starting to track how much money this costs, because we can make people aware of these types of things.

SIMON BROWN: You made the point. We’re driven by desire for short-term emotional comfort. I get that, I’m not knocking that in the least, and that’s the hard part of it.

The data is fascinating. Are you able as Momentum Investments to put a pop-up and say, ‘pause a moment’? Or is that sort of beyond your ambit, crossing that line of advice versus investment?

PAUL NIXON: That’s a great observation, Simon. I think that’s where the world is going. So I think that if we look at this whole debate, if we look at ChatGPT and AI, [which have] taken the world by storm, I don’t think it’s necessarily a matter of that replacing advisors. I think humans and tech are good at different things at the moment and, luckily for us as humans, we’re going to be using these kinds of technologies to give us kind of ‘in the moment’ financial education. So that’s a big gap.

I think where the world is going, probably [for] a company like Google – I’m maybe surprised not to see them there already – it might just be a kind of a legislative thing. But if you think about it, your financial advisor can’t be with you when you swipe your credit card, but Google’s there every single time you add something to a shopping cart.

So Google can sort of pop up and say, ‘Listen Simon, just remember that if you go through with this – by the way I see you’re purchasing on credit – this is actually what this flat screen TV is  going to cost you, and that’s going to mean 200 bucks less in retirement. Do you still want to continue?’ That kind of stuff.

I think that’s where it’s going to help us bridge this intention action gap. We all want to retire with more money. We all want to send our kids to great schools. So knowledge is not the problem. The problem is that in that moment we tend to heavily discount or over-discount the future benefits of retirement and saving money because we want that purchase in the moment.

So I think technology here is really going to play a key role in helping human beings make better choices.

SIMON BROWN: It brings to mind two books that I’ve read over the many years. The first is Thinking Fast and Slow – that’s just how our brain works. But the other one is Nudge, which was a brilliant book. We see Discovery really did it with their Vitality, and it’s moving a lot more into financial services, where to the point it might not be financial advice, it might just be a pop-up that asks a question and gets me thinking in a way that might be better for me.

PAUL NIXON: Precisely, it’s exactly this new era. And what we’re starting to do at Momentum Investments with machine learning is now we’ve got the engines available for this kind of technology. You’ve already mentioned it. We identify different archetypes of behaviour, using things like machine learning, [with] which we just use a ton of data – and, again, AI and machine learning is good at getting through a stack of data – and we can identify different behavioural patterns as well.

So we see that it’s not just about market crashes where people do so, it’s also about bull markets where people become overconfident. This forms the basis of that automated engagement, which again then augments the advice. So it’s not about replacing an advisor, it’s about helping the advisor to say, listen here, I must think like in Minority Report. Remember that old movie with Tom Cruise where you kind of get arrested before you commit a crime, because someone else knows you’re going to do it? It’s that kind of thing as well. It’s like these clients are probably feeling like this at the moment; you might want to  give them a call, you might want to pop in a mail, you might want to send them a message – and here are the tools to help you give better advice.

SIMON BROWN: I like it. It’s not denying the client’s emotion, because that emotion is real. It might be poor judgment, but it’s really emotion.

We’ll leave it there. Paul Nixon, head of behavioural finance at Momentum Investments, I appreciate the time.

Listen to the full MoneywebNOW podcast every weekday morning here.