Emotions and investments do not mix. A good advisor will do his best to act as a guide in the face of the panic or euphoria that stock markets may provoke.
Michel Villa learned this lesson the hard way. He was fired as a trader at Laurentian Bank because of the poor performance of his investments.And what led up to his firing? "I loved the action! I provoked it. I was emotional. I did not listen to the market. I had become arrogant. Nobody told me. He fully realized it when he was let go.
Since then, Villa has built a training course on emotional intelligence and investing. It exposes the major role played by emotions in investing and the key role that an advisor can play to counteract this phenomenon. The Insurance and Investment Journal attended one of his presentations offered by Bridgehouse last May in Quebec City and interviewed him afterward.
"Good advisers become architects of choice. They will guide investors to make good decisions and stop them from being too emotional. Investors are human beings. They are inclined to make decisions based on emotion, especially when it comes to their money," says Villa.
A range of emotions can influence attitudes about finance, he adds. "These emotions result in choices that compromise long-term plans, the latter being the essence of successful investment."
A lesson in humility
In addition to his personal experience, Villa has built his training on that of Richard Thaler, Nobel Prize winner in economics in 2017 for his studies on behavioral finance and his work on the psychological and social mechanisms that affect decisions made by consumers or investors.
Thaler says all decision-making is influenced by biases such as emotions, environment and instinct. The investor is led by these external factors that may ultimately lead to making very bad choices. Villa goes further and talks about self-destructive behaviors. He advocates well-being in financial management.
Villa says that finance is a sector that values analytical thinking, facts, calculation, statistics, reason and logic. These functions, which are essential for success on the stock exchange, are located in the left hemisphere of our brain. There is, however, a major counterpart, the right hemisphere, the seat of our emotions. The right hemisphere can counteract the game plan set by an investor and his advisor.
All sorts of other factors influence the small investor: the economic and political news of the day, exposure bias, etc. Another element is easy access to investment data. Advisors have observed that clients who check their returns twice a day developed anxiety even though it is normal for the stock market to fluctuate daily.But anxiety is a very bad driver. Some will be anxious to buy during a period of frenzy, others will be anxious to sell in the case of a major market correction.
For Villa, there are two types of behavioral bias in investment. First, there is cognitive bias, the errors of judgment that are related to the processing of information. Then comes the emotional bias, the errors of judgment related to thoughts, attitudes and feelings. Unfortunately, says Villa, they are more difficult to correct than cognitive biases.
"With investments, you have to stay the course. The financial advisor becomes an emotional guide who will help his client take a step back. He has to listen to him and then present his arguments to him."
Villa also listed some rules for financial advisors. The first: the advisor must become the devil’s advocate of his client. "The client has to be calmed down."
As for the skill that the advisor must have to do this, it is not something that comes naturally, says Villa. It is something that must be practiced.
"The advisor must have a plan, respect it and be passive in the long run. It is often better to do nothing during a crisis. This is often the best strategy."