The Heart of the Matter Is the Matter of the Heart

In March 2020, the markets tumbled and the S&P500 fell about 30% from its peak. While many investors panicked, we were busily engaging and assuring clients. The key message that we sent was that our clients should ignore the short-term volatility of the markets but instead focus on staying invested for the longer term and keeping to the plan that we have put in place together. This is because when we have invested in a globally diversified portfolio, used instruments that do not try to outguess the markets and kept investing cost low, score of evidence has shown that our portfolios will give us the required returns in the long run. And since the bottom of the markets on 23rd March 2020, the S&P500 has gone up by about 85%. While this is not difficult to understand, many investors still panicked. This is because while the “head” understands the logic of staying invested, the “heart” do not and so we jump out of the markets when we should not. To connect the “head” with the “heart” and remained seated on the investment roller coaster, we need to invest according to our risk appetite. Sounds easy? Not so.

In early 2003, Providend developed a framework to determine the risk appetite of investors and the kind of portfolios/instruments that are suitable for them. It is a 3-factor framework that consists of an investor’s (1) need, (2) ability and (3) willingness to take risk. The need to take risk is determined by the required rate of return of the investor. If the required rate of return is high, then the need to take risk is also high and vice versa. The ability to take risk depends on many sub-factors such as age, time horizon, financial health, physical health, sufficiency of insurance coverage, marital status, investment amount, etc. The willingness to take risk is typically ascertained by a set of risk questionnaires. The framework then correlates the 3 factors to arrive at a conclusion. Using just 2 sets of combination to illustrate, assuming an investor has a low need and ability to take risk but a high willingness to take risk, he should not take risk. But if an investor has a high need and ability to take risk but is unwilling to do so, he should take the risk that he is able to bear and get the returns that he needs or accept the consequence due to lower returns. This will have implications to his wealth plan.

18 years have passed since we developed this framework and we have made many improvements along the way. But as we got deeper in our work with clients, we realized that it is not easy to accurately assess an investor’s willingness to bear risk. This is because, while determining the need and ability to take risk is metaphorically a matter of the head, something very concrete, quantifiable and thus easier to establish, a person’s willingness to bear risk is a matter of the heart, something abstract and not easily understandable.

From our experience, there are broadly 2 big factors that influence our “heart” towards investing – How we are wired and the significant events in our lives.

How We Are Wired
All of us are wired in a certain way when we were born. This is manifested through our behaviours as well as our thinking preferences. According to Emergenetics, a US company that developed the personality tool of the same name, a person has 4 thinking preferences (analytical, structural, conceptual and social) and 3 behavioural attributes (expressiveness, assertiveness and flexibility). These traits influence how a person makes decisions. Space constraint does not allow me to explain these 7 preferences and attributes in depth but as an example, a person who has an analytical thinking preference and is less open to changes might be unwilling to take risk if a new investment idea is presented to him and he does not have enough facts to help him understand it. On the other hand, an investor who is a conceptual thinker and more open to changes may be more willing to invest in this instance. Of course, these examples are too simplistic, but the point is, how we are wired affects how we think, which in turn causes how we feel and influences our willingness to take risk.

Significant Events in Our Lives
Most of us will remember significant moments of our past. Fond memories of family holidays, quarrels between our parents or even a divorce. We may even recall vividly how we were bullied in school, role models that we looked up to, or death of a loved one. We may even remember our first break up, our wedding and how it felt when we had our first child. Some of us may remember how we narrowly escaped death either due to a serious illness or a natural disaster in another country. These significant events in our lives (including living through the pandemic right now), shaped our worldview and also created filters which influence the way we see, think and feel. As an example, if one grows up in a family where he witnessed how his parents divorced due to his father losing his entire fortune to the stock market and how he had to pay the loan sharks for the money he borrowed to invest, this person may associate investing with gambling and thus cause him to be unwilling to take investment risk.

By now, I hope we realise that simply answering a few questions from a set of risk questionnaires is insufficient to understand our willingness or unwillingness to take risk. For without understanding the reasons behind how we feel, we give in to our heart’s desire (which may not always be the right thing to do) and make investment decisions which may be inappropriate and thus do not achieve the desired outcome.

David is my personal trainer. When I first started with him, we had a few conversations regarding my fitness goals (my need). He understands my motivation behind them (my willingness). He also knows my medical background, my age, my past injuries (my ability) and with that, he developed a plan for me. Every week when I see him, my willingness to go through the grind, varies. David tries to understand the reasons behind those bad days and sometimes, he still pushed me on but on other days, he took it easy on me. I trust David because I know he is trying to keep me on track but yet he does not do it beyond my physical ability. My fitness level has gone up since I worked with David. I don’t think I would have achieved it with a fitness app. In many ways, hiring a good adviser is like this. Besides developing a wealth plan that make sense to the “head” (which is the easier part), he needs to be skilled in understanding the heart so as to tutor it to act appropriately when it is unwilling or over willing to do so. Because while investing is not difficult, it is complex, and the heart of the matter is really the matter of the heart.

The writer, Christopher Tan, is Chief Executive Officer of Providend, a Fee-Only Wealth Advisory Firm. Besides being financially trained, he is also an Associate Certified Coach with the International Coach Federation.

The edited version of this article has been published in the Money Wisdom Column of The Business Times Weekend on 22th May 2021.

For more related resources, check out:
1. How Providend Helps Affluent Families Have a Good Investment Experience
2. Hiking and Wealth Management: The Great Adventure
3. Conversation With Clients One Year After the Crash


We do not charge a fee at the first consultation meeting. If you would like an honest second opinion on your current estate plan, investment portfolio, financial and/or retirement plan, make an appointment with us today.

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