The Psychology of Money

As coronavirus took hold earlier this year, we experienced a swift and brutal downturn in global stock markets in excess of 30%. At the time of writing there has been an equally dramatic recovery, and global stock market prices are now higher than they were prior to the downturn.
The point of this article is that markets are incredibly difficult to predict and investors can be their own worst enemy. Anyone who jumped out of the market during the recent decline will have missed out on a huge upturn.

If you’re looking to build up wealth to fund your later years, you might be thinking that there could be a recession on the way and a huge amount of economic uncertainty. What should you do?
I’d like to strongly recommend
a recently published book, ‘The Psychology of Money’ by Morgan Housel. This book explains that doing well with money isn’t always about what you know, it’s about behaviour. We often think that investing is about mathematics and theory but most of us make financial decisions based
on emotion. We’re humans, not spreadsheets.

One of the stories in the book is a salutary tale. Please forgive the US-centric nature of this: the author is American, but it contains a universal truth. Let us say that an investor saved $1 per month from 1900 to 2019 in the US stock market. Regardless of whether there is a recession or steeply rising stock markets, she keeps investing each and every month. The author calls this investor Sue. However, other investors will find investing during a recession too scary and will only invest their $1 per month when the economy is not in a recession. During a recession they sell everything, invest in cash and then place the money back into the stock market when the recession ends. The author calls this investor Jim. A third investor sells six months after a recession starts and then takes a while to regain his confidence, buying back in six months after the recession ends. The author calls this investor Tom. At the end of 2019, Sue had $435,551. Jim had $257,386. Tom had $234,476. How each investor behaved during market downturns had a massive impact on their lifetime returns. Timing the market is very unlikely to work as a long-term strategy. Automating monthly investment and ignoring short term ‘noise’ puts the odds firmly in your favour.

Nothing in this article should be taken as personal advice (I know nothing about your circumstances 1 ) but sometimes the right thing to do is counter intuitive and emotionally painful. Increasingly, the role of a good financial planner is to be a financial coach, helping you avoid the big mistakes and guiding you through tough times. Many aspects of investing are simple in theory but extremely difficult to carry out in practice without some help. If you’d like a chat, please don’t hesitate to get in touch.

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