Feelings of Loss vs. Gain

On CNBC’s “Squawk on the Street” show today they discussed investors’ short-term memory and how it can trip them up. It was a good show in explaining how investors feel about the pain and pleasure associated with losses and gains in their portfolios. I’d like to add and explain the dynamics of facing a likely gain vs. a sure loss.

The theory known as "Prospect Theory", originally described by Daniel Kahneman and Amos Tversky, says that individuals are much more upset by prospective losses than they are pleased by equivalent gains. Therefore, the loss of $100.00 would be twice as painful as the pleasure received from a $100.00 gain.

In my work with both consumers and financial advisers, I've found that people are willing to take more risk to avoid losses than to realize gains. In other words, when faced with a likely gain, investors are more likely to be risk-averse, while when faced with sure loss, they turn into risk takers. You can see how this pattern could affect average investors. It's a spiraling effect with one bad investment decision threatening them with a sure loss, which will lead them to take more risks in order to avoid this loss.

I’ve seen this theory in action with some of my private clients in the last six months. Their worry about loss had become unmanageable and they no longer felt in control. All they wanted to do was sell and stop their losses. If they had sold, their timing would have been impeccable being right at the bottom.

Even The Wealthy Can Feel Financially Insecure

Yesterday I spoke to a client who sounded very different from a year ago. She no longer has the sense of optimism and joy about her recent retirement. She, like other high net worth individuals who lost a significant percentage of their wealth, are feeling insecure. In a recent national survey, high net-worth consumers were much more concerned about their sense of security than their quality of lifestyle.

This makes sense as there is a hierarchy of needs that we all relate to in life with our need for security at the very base and foundation of other higher needs. Unless that security need is fulfilled, human beings are not interested in seeking to fulfill higher needs such as achievement or self-actualization.

Once our security needs are fulfilled, we can then focus our energies in fulfilling our other needs with a sense of optimism and confidence. Meanwhile, most consumers are playing it safe and doing whatever they can do to feel more secure--even the wealthy.

Everyone is looking for some reassurance that they'll be OK--financially and emotionally. The important point is for all of us to get in touch with our individual financial situations and definitions of security and then be deliberate in achieving and maintaining it. Only then will we be able focus and realize higher needs, take some risks and venture beyond our comfort zone.

Can Money Emotions Be Controlled?

I watched a CNN segment today on the potential of controlling the emotions of traders on the floor so that they could make rational vs. emotional decisions while trading. Dr. Lo of MIT is working on such an experiment trying to ultimately improve their performance. If his experiments proved fruitful, he would propose a central risk manager on the floor of the exchange who would monitor the levels of trader distress so that some coaching intervention could identify and then control the distress response trying to manage and eliminate any irrational decisions.

While this intervention may ultimately prove to be a fruitful plan, a less intrusive approach that would heighten self-awareness can be effective and would be preferred in my opinion. By helping people in all walks of life, not only the financial industry, discover and manage their money personalities--the attitudes and feelings which make an impact on money management--they have been able to make better use of their money as a result.

My first real experience and proof that this approach could be effective in helping traders and brokers control their money emotions was prompted by Black Monday of October 1987 when the market plummeted. It created havoc for traders, stock brokers, financial advisers and their clients.

The first branch of a national brokerage firm I worked with proved to be a challenge because the majority of their clients were retired, wealthy and conservative. The first step was to give the brokers insight into their unique money personalities via the Moneymax Profiling System so that they would understand how their attitudes and feelings about money may be projected in their consultations and work in managing money. Second, it was important to give the questionnaire and review the results with all of their clients. Not only was it a meaningful way to reach out and communicate at a very stressful time, but it was an effective way of documenting and assessing in an objective way what their clients were thinking and feeling about their money at the time.

In that particular economic climate much like today, it is extremely important to understand what is most suitable and how to gauge and manage comfort levels to avoid feelings of distress. Moneymax makes it possible to assess and manage feelings of anxiety, emotional feelings, lack of trust, impulsivity and other important traits.

That program was highly effective and many subsequent programs have been equally successful in helping people discover their money personalities and how to profit from them. If you have any interest in learning more about the subject and services that may be available to you personally and/or professionally, go to www.kathleengurney.com and www.financialpsychology.com if you'd like to explore using any of the information or services in your work with clients.