But it’s not that simple. Pain-driven activities typically get our attention first — they are the nagging, annoying tasks we simply can’t avoid. Time and time again we sideline gain activities in favor of preventing pain.
Helping Clients Overcome Loss Aversion
As financial professionals, it is our job to help ensure that our clients prioritize gain ahead of pain while also obtaining some level of comfort with pain. In our industry, we’re all familiar with the idea that investors are driven by fear and greed. But let’s put aside the negative connotations of greed for a moment and stay focused on the concepts of pain and gain.
One thing we know about the markets is that they are sure to go up and down. Loss aversion is a well-established cognitive bias in behavioral finance. While investors love to make money, they hate losing money much more. Time and again, investors underperform the benchmarks and do not achieve their long-term goals because they sell out of the market at the wrong time in order to avoid pain.
Running from Danger
Ironically, clients would have the same emotional response to a bear market as they would have to an actual bear chasing them in the woods. In either scenario, adrenaline spikes, areas of the brain responsible for rational decision-making are reduced, and the body turns on systems that can help a person run away from danger and preserve their safety.
The ability to conserve energy from systems that aren’t absolutely necessary in favor of contributing energy to systems that can help us run away from danger made a lot of sense to our ancestors on the plains of the Sahara thousands of years ago. Unfortunately, those same systems can wreak havoc on our decision-making capabilities, and even our health, if they aren’t kept in check.
Focusing on Growth and Safety
At Clark Capital, we focus on risk management so that clients can avoid making emotional decisions driven by loss aversion. One way we help investors prioritize gain over pain in their investment portfolios is by giving them the option to take a small piece of their portfolio and hedge it by using volatility instruments that track the VIX, such as ETFs like VXX, VIXM, and individual options contracts. For advisors and clients who choose to overlay a hedging strategy on a portfolio, the majority of the portfolio is focused on providing long-term gains.
The comfort of knowing that a small portion of the portfolio is invested in vehicles that typically go up when the market goes down can help investors focus on their life goals, such as funding a child’s education, buying a second home, or leaving a legacy.