Saturday, June 11, 2016

Emotions and Investing ... Low Cost and Knowledgeable Fiduciaries Beat Robo Advisers Every Time

Emotions are often determinative in individual decision making. The lack of objectivity can lead us to make really bad and uninformed choices at important and stressful times. That in turn can result in long term and unnecessary pain.

So while we all have the capacity to act rationally and objectively, in times of perceived peril we are prone to do just the opposite. And while we can't change human nature, we can and should be aware of our propensity to do the wrong thing when tired or under stress.

Negativism and emotionalism can be harmful to our health, financial and otherwise.

Imagine if Robo Advisers Could Do Emotions has these cautionary words of wisdom and advice for us mere mortals:

"Andrew W. Lo is the Charles E. and Susan T. Harris Professor at MIT Sloan School of Management, director of the MIT Laboratory for Financial Engineering, principal investigator at MIT Computer Science and Artificial Intelligence Laboratory, and chief investment strategist at AlphaSimplex Group.

At a conference last year, I was approached by an audience member after my talk. He thanked me for my observation that it’s unrealistic to expect investors to do nothing in the face of a sharp market-wide selloff, and that pulling out of the market can sometimes be the right thing to do. In fact, this savvy attendee converted all of his equity holdings to cash by the end of October 2008.

He then asked me for some advice: “Is it safe to get back in now?” Seven years after he moved his money into cash, he’s still waiting for just the right time to reinvest; meanwhile, the S&P 500 earned an annualized return of 14% during this period.

Investing is an emotional process. Managing these emotions is probably the greatest open challenge of financial technology. Investing is much more complicated than other chores like driving, which is why driverless cars are already more successful than even the best robo advisers.
Despite the enthusiasm of tech-savvy millennials—the generation of investors now in their 20s and 30s who are just as happy interacting with an app as with warm-blooded humans—robo advisers don’t take into account the limits of human cognition; they don’t make allowances for emotional reactions like fear and greed; and they can’t eliminate blind spots. Robo advisers don’t do emotion. When the stock market roils, investors freak out. They need comfort and encouragement. During last August’s stock-market rout, Vanguard Group told The Wall Street Journal it was “besieged” with calls from jittery investors and had to pull volunteers from across the company to handle the call volume."

Summing Up 

While we can't take the emotions out of stressful situations, we can  learn to recognize them and not react by doing the wrong thing in the heat of the moment.

This too shall pass should generally be the operative phrase of caution when witnessing stock market ups and downs, and especially the downs.

And recognizing that we are prone to adopt negative behaviors in times of stress can help us to take some deep breaths, sit still and do what's best and in our long term interests --- nothing.

Having a trusted and knowledgeable financial adviser who has 'been there and done that' also makes a great deal of sense.  

And if he has his own skin the game, so much the better. 

That's because the friendly knowledgeable and experienced adviser won't do to us that which he won't do to himself.

That's my take.

Thanks. Bob.

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