The turmoil in the financial markets has played out in dramatic fashion by daily media coverage taking on an almost apocalyptic tone. With headlines screaming "unprecedented" and "crisis," it's no wonder so many investors are scrambling to get out. If one emotion has prevailed over the last few months, it's fear.
As a financial advisor, you've seen this fear in your clients and are devoting most of your efforts to serving as the voice of reason. But let's face it - even the most logical financial advice is useless if a client refuses to follow it. Worse yet is the advisor who doesn't follow his or her own advice. A major disconnect often exists between what we know we should do and what we actually do. For example, we know we should buy stocks low and sell them high - but most investors do the exact opposite. Likewise, the U.S. arguably knows more about nutrition than any other country, yet statistically we're one of the most obese nations on earth.
The source of this curious tendency to contradict our powers of logic and common sense can be found in the inner workings of the human brain. You needn't be a neurologist to understand how the physiology of the brain affects human behavior, and learning more about how your clients' (and your own) brains are wired is one of the most valuable things you can do as an advisor.
Much of our irrational behavior may arise from the primordial functioning of an area of the brain called the amygdala. As Pogo said, "We have identified the enemy, and the enemy is us." Or in this case, the enemy is our amygdala.
So what is the amygdala, and why is understanding its function so important? The amygdala is approximately the size of a grape, and can be found near the center of the brain. It is the source of our fear and rage. As an ancient part of our brain, it's function has been invaluable to the survival of our species.
Have you ever narrowly missed an accident while driving your car and felt the adrenaline, or watched a scary movie and jumped at a particular scene? You have the amygdala to thank.
However, notice the difference between these two events - one was real, and the other an illusion. It seems that for the amygdala to fulfill its function in a timely manner, it drives behavior instantly, before we have a chance to contemplate our actions.
The sight of a lion running toward you will immediately stimulate your amygdala. As you run away, your brain will automatically direct all available energy to our limbs to facilitate a rapid escape. Your immune system will essentially shut down, as will your digestive system. As Roger Hall, a psychologist who provides executive coaching to business owners, puts it: "In this moment, our body doesn't care about digesting lunch; if you don't get away from the lion, you'll be lunch."
Your brain is even capable of amplifying your normal abilities in moments of crisis - hence the 100-pound woman who suddenly gains superhuman strength and lifts a car to save her child trapped underneath.
But survival in the wild is much different than survival in the stock market. In fact, we are wired to fail as investors, because we let fear guide our decisions. Fear also poses a significant danger to an advisor's practice -- when an investor is gripped by fear, he often loses faith, both in his investments and in his advisor.
High stress or fear over what might happen in the future puts the amygdala into action. Low doses of adrenaline dumped into our system from the adrenal glands located above our kidneys lead to high blood pressure, digestive issues such as ulcers and a compromised immune system, making us more susceptible to illness. When you know how the amygdala functions, you begin to understand the statistics that indicate the majority of illness in this country is psychosomatic -- caused by our mind rather than an actual disease.
You could also argue that investor failure is largely psychosomatic. DALBAR has done research on flows in and out of mutual funds, and the findings indicate that human emotion has been responsible, historically, for lost opportunities as high as 77 percent. The amygdala is the primary engine driving this behavior.
Mental stress is largely born of a fear that is more perceived than real. A common acronym for the word fear is "false evidence appearing real." If your electricity is out, it's easy to be convinced it will stay out indefinitely. Sitting in a traffic jam, it's easy to believe you'll be in it for an insufferably long time. However, we have all experienced the lights coming on unexpectedly, and before we know it, we're clear of the traffic jam.
As important as it is that we understand how the amygdala affects our clients' behavior, it is just as important that advisors recognize that they can be slaves to their amygdalas as well. Many advisors have contributed to the investor behavior that has historically led to millions of dollars in investor losses. Reacting as if they were under attack by a lion, advisors often recommend that their clients flee at some of the worst possible times.
So what can an advisor do to help clients avoid making decisions based on fear?
Here are three recommendations:
- Preparation: The best course of action for our financial success may not be speculation or even education. Be prepared for the inevitable moment when you and/or your client believe four of the most expensive words in this profession: "This time is different." Constantly reminding your clients that this belief will come and helping them to avoid making the mistakes of the masses is your most important role as an advisor.
- Implementation: Implement a long-term disciplined investment strategy void of speculation that is designed to carry you and your clients through the storm when everyone else is disoriented.
- Rope and wax: Just as Ulysses strapped himself to the mast of his ship and put wax in his sailors' ears, advisors must consistently protect themselves and their clients from the inevitable barrage of negativity from the media. The fear can be contagious, and the more one listens to it, the more likely the amygdala will step in and take over.
Money can conjure up some of our strongest emotions. Many marriages end over money, and it is the source of countless other forms of human suffering. Fears surrounding our money can cause the most rational individual to behave in ways previously unimaginable. The advisor who understands the basic functions of the human brain and the anatomical origins of fear is the advisor who may be better prepared to help his clients make logical decisions.
Steve Luckenbach, regional vice president with Jackson National Life Distributors, is a 22-year financial services industry veteran and popular speaker on the topic of investor behavior.
