Fight or Flight in Finance
These are unprecedented times. And most of us are concerned for our health AND our finances. But it may be helpful to understand that, whether it’s something as simple as a skunk in the yard or as complex as a global pandemic, the way we react is the same. Understanding this can be critical to avoiding the irrational decision making that can happen at times like these—often making things worse.
The psychology of fear
Psychology teaches us that in stressful situations, we try to assess and understand three things—proximity, novelty and urgency. For example:
Concept
What it means
In context with coronavirus
Proximity
How close is this to me and my life
Even if we are lucky enough to not have a friend or family member with the virus, politicians and celebrities we often see in our living rooms now have it—that makes it seem close.
Novelty
Is this new thing an opportunity, a threat, or irrelevant?
This is a very new virus, and the little information about it seems to change each day making it seem very threatening.
Urgency
How quickly do I need to respond?
The speed with which the virus seems to be spreading makes it seem quite urgent that we take action.
Avoiding the reptilian response
It’s important to understand that when threats seem close, new and urgent, we often revert back to a “reptilian brain”—which acts out of instinct and leads us to a “fight or flight” response where we either run away or take a stand. This same psychology plays into our portfolios and the decisions we make as investors. But understanding where our mind goes may help us to make more rational decisions. Consider how this current situation could play out:
Concept
With portfolio volatility
The fight or flight response
Instead consider
Proximity
Major indexes and portfolios alike are down, touching almost every investor
(flight)
Sell out of positions and move to cash
Where there are down sectors, there are also opportunities. Not only to buy low, but also in sectors that are experiencing surges in demand as the economy and world shifts focus.
Novelty
The market reactions may seem different or new to us
(flight)
Sell out of positions and move to cash
There have been market crises before, including the Great Financial Crisis of 2008, Black Monday in 1987, and many others. But history has shown that each time, the market has come back stronger.
Urgency
We feel like we must do something now
(flight)
Sell out of positions and move to cash
You cannot profit from the market if you are not in it and over the long term. And your portfolio may do even better if you hold onto your equities and/or buy new ones at currently lower prices.
What you can do now
There is no understating how scary coronavirus seems to be. My hope is that with a better understanding of the psychology of fear, you can make better decisions in this and other stressful situations. Remember to:
- Look for the opportunities and silver linings (lower cost basis and more family time)
- Put things in perspective (we have seen extreme market volatility before)
- Take your time and focus on the big picture (investing is a marathon, not a sprint)
About the author
Joseph F. Coughlin is the Director of the Massachusetts Institute of Technology AgeLab. His research provides insights on how demographic change, technology, social trends and consumer behavior will converge to drive future innovations in business and government. He is a teacher, a best-selling author, a frequent contributor to numerous leading publications, a sought-after public speaker and news guest, and a consultant to many leading corporations and governments around the world.