We’re all confident investors when the market is going well but the minute things take a downturn it’s a different story, says financial planner Liz Koh.
“[It is then that] we realise what our true relationship with risk is and there is a lot of psychology behind that.”
Koh chats with Kathryn Ryan about understanding the reasons behind feelings towards risk and volatility, learning how to invest safely, and taking advantage of the opportunities.
Chinese investors watch stock market movements at a securities company in Beijing. Photo: AFP
There are several aspects to why we feel the way we do about risk but it’s not loss rather our expectations of outcomes versus reality that is the driving force, she says.
“When people are risk-averse, one of the things is it’s about their personal financial situation so obviously if you haven’t got a lot to go and come on then you’re going to be a little bit more conservative.
“There’s a lot of reasons why we can be more risk averse from an emotional point of view.
“Quite a lot of that comes from our early childhood, by things parents told us when we were little, you know, you remember the old sayings ‘money doesn’t grow on trees’, ‘save the pennies and the pounds will take care of themselves’.”
These can affect our relationship with money and make us more conservative in our financial decisions, she says.
“They echo in your mind when you’re making financial decisions, you remember your mother or your grandmother or your father or your grandfather talking about these kinds of things.
“But also, the other thing that impacts us quite significantly is our past experiences … everybody’s got a story to tell about somebody that’s lost a lot of money.”
It’s important to remember in those situations that losses are caused by bad financial decisions, not the market, she says.
“So those instances are a reminder of those two basic principles of diversification and time in the market.
“If you do those two things, then you shouldn’t lose money and those stories that we’ve all got about people really who have made poor financial decisions, it’s not the market’s fault as such, there’s always volatility.”
Financial literacy has a big part to play too, she says, and a lack of it can cause loss.
"There’s some interesting research that was done some years ago by a guy called Harry Markowitz who won a Nobel prize and he looked at the relationship between risk and return.
“Interestingly what they’ve found is that investors feel pain of a loss probably more than twice as strongly as they feel the enjoyment of making a profit, so it’s a little bit skewed.
“Hence why people are very confident when the market’s going really, really well and they’re participating in those gains but along comes a downturn and they flee because of this principle that their feelings about loss are much stronger than their feeling about gains.”
As a result, this emotional investor behaviour drives a lot of volatility in the share market, she says.
"If you took that emotion out of the share market, you’d have something that’s a lot less volatile because really fundamentally what drives share prices to go up is the earnings of the companies that are listed on those markets.
“And yes, we go through economic cycles with a bit of up and down and that will be reflected in the earnings and the share prices, but it’s all magnified by this fear and greed that’s coming into play.”
Koh suggests the way around this problem is to familiarise yourself with how markets work and find a way to take advantage of those opportunities.
“When you get to a situation where that fear and panic has driven the share price below its objective value, that’s what you’d call a bargain.
“Look for the signals where you can see those bargain buys happening … and when it eventually fixes back again, which it always does, that’s when you make the gains."
Liz Koh is a financial planner specialising in retirement planning. This discussion is of a general nature and does not constitute financial advice.
