Optus’ biggest failure was not the national outage that occurred earlier this month on 8 November or the 2022 cyber-attack when hackers stole the personal data of more than 2 million customers.
Although customers were rightfully angry, people generally understand that cyber-crime is increasingly prevalent, sophisticated and aggressive, making it impossible for companies to guarantee security. Consumers can even forgive a major technology glitch but what they can’t accept is businesses failing to adequately plan and prepare for such scenarios, given their inevitability in today’s digital age.
Planning for an uncertain future, including a potential crisis, is what financial advisers assist their clients do.
The entire life insurance industry is built on crisis mitigation. Accidents, illness and premature death are all, sadly, part of life.
Similarly, a financial crisis is for financial advisers what a network outage is for a telco, yet how many advisory firms have a financial crisis management plan?
Given the ever-present risk of a major market meltdown in the current economic and geopolitical environment, there is no excuse for being ill-prepared.
As discussed in my last column, crises can be categorised as macro (recession, war, natural disasters) or micro (job loss, divorce, sickness, the death of a loved one).
This article focuses on macro events, namely a financial crisis. It examines common human emotions and behaviours during a crisis and how they impact decision-making. It also explores the important role financial advisers can play during a crisis and how, by preparing ahead of time, they can pre-empt client actions and reactions, and identify potential solutions.
Emotions are not just feelings
Emotions can significantly influence financial decision-making.
For example, fear and anxiety can lead to hasty decisions, such as panic selling, that can exacerbate a situation.
On the flip side, fear can also result in inaction because people don’t know what to do.
In the same way someone in physical danger can be paralysed by fear, there is a tendency for people to do nothing and bury their head in the sand during a crisis.
A crisis can also conjure up feelings of regret. While a market downturn is beyond anyone’s control, it can lead to significant personal financial loss, which can spark feelings of self-loathing and regret.
People who blame themselves for bad choices in the past are often scared to make decisions in case they make another mistake.
Even the possibility of regret is enough to cause paralysis. For example, an investor might avoid selling a losing stock, hoping it will rebound, just to avoid the regret of having made a bad investment.
In the study of behavioural finance, this is referred to as avoidance behaviour and explains why some clients ignore urgent phone calls from their adviser, cancel important meetings, and delay making necessary financial decisions. Their hope is that the situation will resolve itself.
Identifying the emotions that people commonly feel during a financial crisis is the first step to mitigating any potential negative impacts.
Mental shortcuts
A crisis situation often requires people to think and act fast.
Not surprisingly, people take mental shortcuts, also known as heuristics, based on what they think has worked in the past. These heuristics are deeply ingrained and often unconscious.
While heuristics can be efficient in every day scenarios, such as determining the quickest route home, it can lead to systematic biases and sub-optimal outcomes in more complex situations.
In the context of financial crises, reliance on heuristics can amplify risks.
It is important for financial advisers to understand the role of heuristics in financial decision-making.
By recognising these cognitive shortcuts and their potential pitfalls, strategies can be developed to foster more rational, informed financial decisions, especially in times of market instability.
Strategies to counter emotional decision making
Emotion-driven decisions aren’t necessarily detrimental, but in the realm of finance, they can often lead to suboptimal outcomes. Some strategies to counteract emotional biases include:
- Financial education: Understanding the basics of finance and markets can provide a buffer against knee-jerk emotional reactions. Remember, though, this education is often short-lived and requires constant reinforcement.
- Diversification: A diversified portfolio can reduce the impact of any single market event and, in doing so, reduce fear and anxiety. This also needs reinforcing in times of crisis.
- Consult professionals: Financial experts including advisers, asset consultants and fund managers can offer a more objective view and help balance emotional reactions with rational strategy.
When putting together a financial crisis management plan, advisers should consider the behavioural biases that can adversely affect decision-making and develop strategies to counteract these influences.
Being prepared for macro crises and knowing how to mitigate the impact of emotions and heuristics is crucial for financial advisers to effectively guide their clients, and their businesses, through any scenario.
Paul Moran is the Founder of iFactFind and principal of Moran Partners Financial Planning.
We have a GREAT crisis management plan. If, as the article says, and we all know, global financial crises are inevitable, the logical thing to do is tell clients that. I’ve worked through several of these events, the first being the October ’87 crash. Through each, my phones were, largely, silent. Why? Because, at every review, clients are reminded that, it not if, but when. they are also told that, if anything needs to be done, we’ll be doing it, so there’s no need for them to panic. Guess what? Few of them ever do.