Human emotions are great if you’re looking for love. But, they may not be so beneficial when making major financial decisions.
One emerging market says it’s taking emotion out of the equation.
Rather than going to a human financial advisor, so called robo-advisors allow prospective investors to sign up online and have software put together their diversification investment portfolio using low-cost Exchange-Traded Funds (ETF).
Robo-advisors taking out emotion?
Bruce Seago, the CEO of ShareOwner, said he’s taking the emotion out of investing by creating a well-diversified portfolio that can be held for the long term, without tinkering with it as the market goes up or down.
“Even professional money managers who you might expect are good at doing those types of things, 90 per cent of the time they will not do better than the broader index itself,” he said.
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“Because a lot of what we do is models-based, we try to be impartial,” said Nauvzer Babul, founder and managing director of Smart Money Capital Management.
“We allow our clients to stay within the risk tolerance that we set on day one. And we force our clients to take profits more than clients are willing to do on their own,” he said.
Babul added, “Where we find human emotion plays the biggest factor with the people that we deal with is in assessing their own risk tolerance. People tend to think they have a higher risk tolerance than what their lifestyle would predict, and vice versa.”
Human emotion is a financial challenge
Lisa Kramer is an associate professor of finance at the University of Toronto and an expert on the psychology of investing.
She said emotions have a significant impact in our financial decisions.
“When people are depressed for example in the fall and winter months, they also become more risk-averse,” she said.
“If you’re more risk-averse for a substantial part of the year then during those periods you’re going to choose safer types of securities perhaps, and this can affect the overall way prices are set in markets for financial assets,” said Kramer.
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Kramer gave the example of retired people during the crash of 2008.
“Many of them folded as the markets were falling, and then they sort of locked in a low value for their portfolio, they had converted it all to cash, and then of course when the market rebounded they ended up missing out on that recovery, so emotions can really get in the way,” she said.
Kathy Waite, an independent financial advisor based out of Saskatchewan, said she agrees removing human emotion is good, but isn’t sure robo-advisors do that.
“I think if anything it could be too clinical,” she said. “I think if people could be dispassionate then robo-advisors could be a good thing but I don’t know how could there be hand-holding in the bad times.”
Waite sees human emotion as the very roadblock that will prevent robo-advising from reaching a sizeable percentage of the population.
“I think that money is a very personal thing, and not many people will actually be comfortable with just dealing with someone on the telephone,” she said
Education is key
Education, it seems, will play an important role in whether emotion gets the best of investors.
“I think they have to be, to some extent, educated about diversification,” said Dr. John Nofsinger, author of Psychology of Investing and professor of finance at the University of Alaska Anchorage.
“We’re forming a portfolio, some things go down and other things go up, that’s what sort of smoothes out and reduces your risk over time. So I think the investor would need to buy into that concept in order to use it.”
Seago also said that investors with robo-advisors can still be led by their emotions and pull out if they see the market going down.
“The so-called robo-investing, it’s investing that is similar in context to any other type of investing, you’re invested in the market, you do have to understand what you’re invested in,” said Seago.
Whether or not robo-advising actually takes the emotion out of financing, all parties agreed on one thing.
“When you’re feeling emotional it’s a bad time to be making financial decisions,” said Kramer.
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