KEY POINTS:
Panicking is bad for your health and your wealth. If our investments are increasing in value irrational exuberance often takes over. At this point, many people forget that investment involves risk.
But when money disappears before our eyes - as it has with the credit crunch - it causes anxiety, anger, fear, disillusionment and a range of other emotions, few of them positive.
If you do respond to your ancestral brain, however, the chances are that you'll do the wrong thing for your finances.
When we feel the emotions related to a financial crash, our biological protection mechanism steps in, says international behavioural finance expert Michael Falk, who was speaking to members of the CFA Society of New Zealand this week.
When the performance of our investments doesn't meet expectations, the feel-good chemical dopamine stops flooding into our brains and our levels of serotonin drop, says Falk.
"This is a new field of research, but it could be argued that we have a biological context and a chemical context that drives our behaviour."
It is perfectly natural, therefore, to panic.
"The trick is not to act on these impulses," says Falk. After all, ups and downs in the market are a natural part of the cycle, in the way a bush fire in Australia clears the way for new growth.
Providing you have your investments well spread, a crash is a time to sit back and take stock. A crash can be a "veritable cornucopia of opportunity" if you have cash in the bank.
But don't expect just because an investment has crashed through the floor against all the fundamentals that it will automatically be a good buy. "The Chinese character for crisis is the same as the character for opportunity."
It's also worth remembering, as US researcher Ned Davis Research found, that the average bull run in the markets lasts 57 months, and recessions 10 months. We're not used to the latter.
Markets are ruled by psychology as much as fundamentals and there are other factors at play. During a crash, investors act irrationally or sell off whatever they can, says Falk, which can depress prices.
When the credit crunch first hit, he says crude oil fell in price at one point against all odds. It was because hedge funds were cashing up the only investments they had that were trading at a profit.
Behavioural finance and neuro-science can also explain why when an investment has dropped by 20 per cent the urge is to sell, or when it has risen by 20 per cent that humans want to buy. "When investments rise [in value] they are like a shiny object for a kleptomaniac."
It's this combination that makes us buy high and sell low - one of the most typical mistakes made by investors in equities, property, and other investments. We follow the herd, says Falk.
Our pre-programming combined with chemicals in the brain explains why some investors behave as they do. I had a conversation with a Blue Chip investor days after the collapse of the company. She panicked and sold her property to the first person who came along.
The trouble was it was part of the hotel lease and by selling it the way she did without taking advice, she put herself in the position of having to pay 12.5 per cent GST on the property to the Inland Revenue Department as well as taking a capital loss.
There is fear on the streets. A steady flow of investors have been calling their financial advisers - especially so last week, says John Rowley, head of Macquarie Financial Services Group in New Zealand.
"There is not a single investor in the world who hasn't had something go wrong," says Rowley.
"We took a policy a few months ago of calling as many clients as we can. But last week clients thought 'what is going on' [with the markets]."
Each portfolio is different. But if the spread is good, Rowley advises that investors ride it out. In other cases there has been room for rebalancing - but not for rash decisions.
"This is a good time for hugging your adviser," says Rowley. "It is not a time to make decisions on your own." He likens it to having a serious illness. Few people would do without specialist advice in that situation.
Instead of panicking, it's a good idea to make the recession a good one by:
1. Taking the time to review current holdings.
2. Not letting the market's short-term gyrations distract you from your long-term goals.
3. Rebalancing if your portfolio is out of kilter to reflect your long-term asset mix.
4. Diversifying risks if you aren't already. Holding all your wealth in one class of asset such as property, equities or - dare I say it - finance companies, isn't smart.
5. Harvesting your tax losses if they can be used.
6. Remembering that even the scariest of bear markets are a normal part of the cycle.
7. Keeping investing and not bailing out of everything.
Panic isn't just hitting equities and other investments. Property investors and homeowners are feeling jittery and some have made bad decisions when fixing mortgages.
Many have been panicked into re-fixing their home loans, which could prove costly. Back in the first quarter of this year, many homeowners and investors fixed their rates for five years - because it was the lowest rate available, says William Cairns, director of non-bank lender General Finance.
Now, thanks to two successive rate drops, those rates, which were between 9 per cent and 9.5 per cent, are starting to look expensive.
Many have been told that if they refix on the date of expiry that they won't have to pay refixing fees. But this is a tactic to get them to sign up, say brokers.
"Banks do charge a refix fee," says Stuart Wills, director of MortgageLink West. "But 90 per cent of the time they waive it if you ask, and brokers ask."
Floating for the short term is a good option, says Cairns, especially if you believe that rates could be as low as 7.5 per cent early next year.
Finally, all that anger, angst and other emotions related to investment panic aren't good for your health. Yoga and deep breathing might be the best short-term solution for some investors.
