Forget Bulls and Bears, focus on the Lizard

No, we don’t (yet) have a team pet. The lizard is our shorthand for describing how irrational people can be when financial markets get stressful. Take market volatility for example. 

The theory when it comes to handling market volatility sounds simple: stay invested. Simple, right? 

But for many investors, the simplest thing to do is often the hardest, especially when the lizard part of our brain takes control and tries to scuttles us back to safety.

The investment facts are clear. Moving to cash and trying to “time” the market doesn’t work. No-one calls the top successfully, and no-one calls the bottom either.

But. Facts don’t matter to the lizard. Moving to cash is always tempting, because the lizard is loss-averse.

Loss-Averse Lizards

I hate losses. I’m sure you do too. It’s a basic rule of human psychology – people everywhere hate the thought of something they own being taken away from them. And these feelings drive our behaviour.

The lizard in our heads will do everything it can to avoid pain. Most of the time, we overrule the lizard in everyday life – we don’t look at every situation from a fight-or-flight perspective.

But in a situation of uncertainty and panic the lizard often reacts first and we struggle to control it. The lizard will always look for the safe option. So for loss-averse investors (i.e. all investors), the last few months have been very difficult.

In general, there are two particularly dangerous periods for people struggling to stay invested.

The Crash – Maximum Fear

The first is when things start going wrong, like March of this year when coronavirus really started to be taken seriously outside of Asia. Sharp falls in the FTSE 100, and scary headlines about death created a perfect storm of fear and panic.

At this moment of maximum fear, we expect calls and emails (my rough rule of thumb is that if the FTSE 100 is in the main newspaper, rather than the business section, the phones will be ringing).

At these times, it is understandable that investors want to sell everything – they may have lost money already, but it feels like the world is going to end. The lizard in their heads is going crazy, telling them not to lose any more, to get out with what they have, to take the safe option and sell.

The Bounce – Maximum Relief

The second danger period is more subtle and unexpected. It’s the recovery phase. When things get back to where they were before the crisis. For investors who stayed the course through the pain and have seen their portfolios rebound, there always comes this bit of time. They start to feel relieved that the money wasn’t lost. Phew.

But then they start thinking about how bad the pain was when they thought they’d lost the money. What if markets fall again? What if it’s worse? Shouldn’t they just be grateful to get out without a loss? The loss-averse lizard starts to panic, resulting in the same old suggestion to take the safe option and sell.

Cage The Lizard

As the markets start to bounce, we’re seeing the questions creep in, with people asking whether they should sell now, and buy back in lower down “when the market falls again”. Or they’ll ask whether the market has gone too far, and if now is the time to hold cash.

Now is the time to cage the lizard. But how?

For us, having a team rather than individuals is crucial in this, as it mitigates the problems that can come with a star manager, no matter how smart and focussed he or she might be.

Most of all, though, we have a tried and tested investment process, designed to deal with uncertain and fast-moving markets. Part of the process is quantitative, looking at dashboards and models covering different economic and market indicators. Part of it is qualitative, discussing policy, views and trends rather than hard numbers. And part of the process is ensuring that we are talking to one another, that information and views are shared clearly and honestly.

This lets us – makes us, even – look forward, rather than back. It keeps the lizard in a cage, and lets the reasoner do the thinking. We are confident that our ability to keep the lizard under control and avoid emotional responses to markets will lead to smoother investment returns in the long run, and work to the benefit of all our clients.

Of course, caging the lizard won’t be, and isn’t, that straightforward for everyone, particularly for someone who’s scared. The desire to hold cash comes from a psychological place. Our latest research piece, Why cashing out could mean missing out aims to help people with this challenge. Using hard data from the past, it aims to calm investors’ inner lizards by helping them understand the long-term impacts of irrational decisions based on fear versus ones based on reason.

You can read this piece and discover more insights from 7IM at www.7im.co.uk.