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Season 2 Episode 5:
Emotional liquidity with Greg Davies

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In this episode of Investment Uncut, show hosts Dan Mikulskis and Mary Spencer catch up with Greg Davies from Oxford Risk. 

Key takeaways:

  • One thing to take away from this episode – patience. The thing that’s on your side is time. So much of investing comes from doing nothing and waiting
  • Most under-appreciated thing in investing according to Greg – complexity, simple stuff works, but there is a lot of jargon and complexity. Start with the basics and don’t let the perfect get in the way of the good
  • Process should be your starting point for investing – so you aren’t shooting from the hip. But spreadsheets become spurious rapidly, you can get mired in optimization
  • 3 simple rules for investing (that could make 90% of investors better off):
    1. Put your money to work
    2. Diversify
    3. Just leave it alone
  • But irrationality and bias plays a huge role
  • There are, up to 160 different documented biases at this point, but that isn’t a helpful way forward either
  • Focus on two tendencies that damage our investment outcomes:
    • Fear: a reluctance to put capital at risk so leaves people under-invested
    • Action bias: a need to always do something to feel in control
  • However involved you are in your investing the right answer is probably “less than you think it is”
  • For the investor the challenge is balancing what is sensible vs what is emotionally comforting
  • Selling assets at market bottoms might not be irrational – it brings relief, control. It takes away the risk of future losses. So it is not irrational, it is just costly
  • What can investors do instead 
    1. Take stock, step back. The problem with long term plans is we don’t live in the long term we live in the here and now
    2. Step out of the short term into the longer term
    3. Build up emotional resilience before the bad event – work on emotional liquidity

Emotional liquidity vs financial liquidity 

  • Running out of Emotional liquidity is what makes you panic and sell at the wrong times. So in making asset allocations and plans you should think about emotional liquidity as much as financial liquidity
  • But you need to build this up over time before you hit a market crash, even the best adviser will struggle to achieve this in the moment
  • An individual’s risk tolerance is not just about a tradeoff of risk and return in the long term. It needs to take into account other factors such as our propensity to react to market moves and impulsivity.
  • An investor might have a high risk tolerance long term but a high propensity to make changes in reaction to market moves, and so needs a portfolio appropriate for that
  • 3 things that matter to determine true risk tolerance, what you should know before setting a portfolio for an individual
  • Risk capacity (your financial circumstances, balance sheet)
  • Willingness to trade off long term goals
  • How willing are you to place at risk a long term goal to potentially “shoot the lights out”

Behavioural or emotional ability to take risk

  • The trouble with risk tolerance as reported by people tends to be pro-cyclical – which leads to bad behaviours. And reported risk tolerance tends to reflect more on how someone is thinking about risk this morning, not over the long term

How does technology help?

  • Keep track of complexity and surface the right insights to the investor (people are “bad” at dealing with a complex and fast moving set of variables)
  • Tech can suggest hyper-personalised actions that are clear-eyed and based on the data in front of us. Tech and statistical methods also allow Oxford Risk to separate out the stable long term risk tolerance from the behavioural dimensions that could damage your ability to take risk
  • What advisers need to practice what they preach – so they understand what goes on inside their clients’ heads

Recommendations

 

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