Don't Just Do Something, Stand There
"Financial decision-making is not necessarily about money."
-Daniel Kahneman
It's 5 am, it's still dark, and the snow is fresh. It snowed about an inch last night. As much as I want to stay in bed and keep warm, our dog, Bingo, and I are out on our morning walk.
As we walk down the trail that's next to our house, I notice other dog prints in the snow and think to myself, "Wow, it's so early, but I'm not the first one walking this morning." Bingo likes smelling footprints in the snow. As she smells these dog prints, her head immediately pops up and looks around. "That's unusual," I think to myself as we continue our walk.
Our regular morning walk is an out and back route on the trail. About 100 yards before our turn around point, I stopped dead in my tracks as I hear the loudest coyote I've ever heard coming from right in front of me. When I saw those paw prints a half-mile back, it didn't occur to me that there were no human footsteps next to them.
One coyote isn't so bad, I think to myself. But then I hear another one yipping on my right side. Then another. Then another. Four or five coyotes are howling all around me. We immediately turn around and head home at a pretty quick pace.
--
Let me tell you a story about a guy I'll call "Paul." In 2008 while stock markets were falling and the media was predicting an apocalypse, Paul watched as his retirement account balances dropped. Paul didn't have all of his money in stocks; he had about half of it in stocks. That means if stocks fall 40%, Paul's balances drop about 20% (depending on what his bonds did at the time). 20% isn't as scary as 40%, but that didn't matter. Paul feared losing more money and sold everything and kept his money in cash.
Stocks have almost tripled since he sold them and he missed out on all of the growth.
--
Let me tell you a story about a guy I'll call "Ryan." Ryan is in his early 30s and has built up a pretty good net worth for himself, especially given his age. A good portion of his assets are in investments, split between retirement accounts and taxable accounts. In 2016, citizens in the United States elected a politician whom Ryan thought is very scary. He assumed that since the scary politician was now an elected official the stock markets were going to crash. Like Paul, he sold everything and kept his money in cash. He feared his net worth getting cut in half or more.
Stocks have been up since Ryan sold his investments and he has not purchased stocks since.
--
In all three cases, something scary happened. In only one case was acting on the fear the right thing to do.
It's natural for us to want to do something (turn around and go home, sell our stocks) when we encounter something scary (being surrounded by coyotes, a down-market, politicians being politicians). It makes sense to distance ourselves from harm's way and do something to change our circumstances. But while it makes sense when it comes to physical threats in our environment, too many of us try to apply the same techniques to financial threats. Counter-intuitively, doing nothing is almost always better for us when it comes to our money.
Do-Something Illusion
We tend to be uncomfortable when we aren't doing anything, especially in times of high stress or when something seems to be going wrong. If this doesn't describe you, chances are you know several people who can't sit still.
I've heard this called the do-something illusion. It describes the idea that our perception of something bad happening (or likely to happen) makes us want to do something about it.
The illusion is that many times, doing something is exactly the wrong thing to do. It's a difficult concept to understand because it feels like doing something is productive; it feels like not doing anything means you don't care.
You can thank your ancestors for this feeling.
Fear and Risk
We're hardwired to avoid risk. This hardwiring is called fear. Fear and risk are deeply rooted in us - for good reason. Back in time, the people who didn't feel fear and underreacted to risks didn't survive to become our ancestors.
Take a look at the grid below. The horizontal axis shows how real the risk is. If something scared us, but we had nothing to be afraid of, I call that "false risk." If we were justified in being scared, I call that "real risk." On the vertical axis is our reaction. We can overreact or underreact. You'll notice that if the risk turned out to be a false risk, it doesn't matter whether we overreacted or underreacted to the risk. However, if the risk was real, the difference between overreacting and underreacting was life or death. Hence we developed a bias toward overreacting.
For example, if you were out looking for food, you might hear some rustling in the tall grass (risk). This could be a tiger looking for food (real risk), or it could be the wind (false risk). Running away or hiding (overreacting) meant survival. Assuming it's just the wind when it's a tiger (underreacting) gets us eaten.
This is why we can confuse a shadow for a burglar, but we'll never confuse a burglar for a shadow. It makes sense when we think about natural risks. Our instinctive behaviors tend not to work with money because, unfortunately, money is not natural.
There's No Money in Nature
The late author and financial planner Richard Wagner wrote that money skills are 21st-century survival skills. Financial Psychology Institute co-founder Ted Klontz notes that our brains haven't received a software update in 150,000 years. That means that our brains are not wired for money. The survival skills that work in nature don't work with money, because money is something humans made up.
This manifests when something scary happens, like falling stock markets. Our gut reaction is to want to overreact and do something about it. We want to change our minds. We want to sell everything and sit in cash. We want to tinker with things. With money, though, inaction is often the best choice.
Hard Work at the Beginning
When I say "inaction is best," I'm not suggesting that you float through life without a care in the world. I'm suggesting that, when times are calm and not stressful, you put in the hard work to get systems and plans in place. Set your policies ahead of time, so you don't have to think about it every time something happens.
Nor am I suggesting that you can set it and forget it. You should regularly revisit your existing plans, systems, and policies. Don't think about making changes in times of high stress, though. The time to make these decisions is when you are calm, and you aren't reacting to bad, scary news.
Process Over Outcomes
It's more important to have a good process than to have good outcomes every time. When something goes against us, it's very tempting to want to do something about it.
Don't.
Put in the work upfront and revisit your plan regularly. Remember, money isn't natural, so the risk/reaction grid changes when it comes to money. Underreacting will give you better results than overreacting.
Live Your Life
Don't waste your life away being obsessed about what the news is saying, or whether you need to tweak your finances constantly. Don't waste your life worrying about whether you made the right or the wrong call.
You only have one life - live intentionally.
Read More:
References:
Dan Ariely, Jeff Kreisler: Dollars and Sense
Farnam Street: The Anatomy of a Great Decision
Farnam Street: Why Bad Things Happen to Good Decisions
Ted Klontz: Exquisite Listening® Workshop
Sarah Newcomb: Loaded
Carl Richards: The Behavior Gap
Richard Wagner: Financial Planning 3.0
Jason Zweig: Your Money and Your Brain
--
If you liked this post, consider joining the Money Health community. By signing up, you'll receive new posts sent directly to you so you'll never miss anything.
© 2019 Money Health Solutions, LLC
Commenti