By Justin Partington, Group Head of Funds
All manner of things cause the stock market to move and particular investments to be made. Geopolitical events, earnings reports and the release of economic data are all regular triggers. But too little time is given to considering how people’s unconscious thoughts are also responsible. Helpfully, the theory of emotional finance, pioneered by Professor Richard Taffler, attempts to redress this imbalance. Here I summarise some of the core insights from his keynote speech at our recent Thought Leadership Series event in London.
Traditional financial theory, while sound in many respects, is guilty of assuming that investing is always a rational, unbiased process. It does not fully account for investors’ unconscious needs and aspirations. In contrast, emotional finance builds on a psychoanalytic understanding of the human mind and its struggle between the unconscious seeking of pleasure and avoidance of reality, and provides various key takeaways.
Firstly, emotions should be divided into two categories: positive and negative. This is reflected by potential gains and losses creating corresponding feelings of excitement and anxiety. Unfortunately, this struggle between conflicting emotions is typically dealt with by the unconscious repression or denial of negative thoughts. Although investors ‘know’ that all investments have the potential to either succeed or fail, in their minds the outcome is inevitably successful.
Speculation and unconscious excitement drive this type of investment behaviour. Emotional finance suggests that this is because investing in the stock market generates many of the same reactions as gambling. Not only do gamblers fail to quit when they’re ahead, but they convince themselves that they’re always capable of turning bad runs around. Both investing and gambling inspire illusions of power and control to defend against helplessness.
This naivety is reflected in investment patterns. Investors regularly exhibit an unconscious need for stock prices to have already risen before having the confidence and trust to invest in them, and often fall into a herd mentality as a result. Perhaps if the findings of emotional finance had been known earlier, the dot.com bubble and 2008 financial crash could have been avoided.
The importance of trust
The reality is that investors are too quick to look for easy answers, as the unpredictability of financial markets makes them anxious. In a recent interview, Warren Buffett reminded us that as investors age, they “get smarter but they don’t get wiser. They don’t get more emotionally stable … when they’re scared, they’re scared.” This underlines why trust is such an important issue for investors. By partnering with the right party, the process becomes less scary. For investors in mutual funds this means looking for managers they can trust; while fund managers reassure themselves through thorough research and outsourcing work to third parties with proven track records.
Emotional finance may still be a growing discipline, but its acknowledgement of unconscious processes promises to expand our understanding of financial and market behaviour far beyond that of traditional theories. Crucially, the key messages of emotional finance are already clear and digestible. Investors who are able to draw on the insights of emotional finance will not only unlock themselves, but also the market.