For more than a century, the U.S. stock market has endured wars, recessions, assassinations, bubbles, and busts. History shows staying invested through periods of volatility has rewarded long-term investors.  Yet behavioral finance studies find investors’ behavior during periods of volatility are governed by emotion.
There is a natural human instinct to make investment changes when markets drop or when markets are rise. (See chart below).
According to Jeff Reeves, editor of InvestorPlace.com, “It’s plain old human emotion prompting folks to sell during a crash and buy at the top of a meteoric run — the very opposite of ‘buy low and sell high’.” So how does an investor remain disciplined in their investment approach during severe market declines or booms?
This is where a financial advisor can help clients in staying the course.
Behavior Finance: Financial Advisors
Michael Kitces, CFP, states, “As financial advisors, we understand that one of the most important (and difficult) things we can do for our clients is help facilitate positive behavior change.” This change may keep clients from selling at a market bottom or buying at the top of the market.
Also, this change enables them to impact their decisions not only for investment strategies, but also planning for retirement, college education, retirement income distribution, risk management, gifting, and estate planning. I agree with Kitces that behavior change, though difficult, is one of the most valuable things we can do as financial advisors. Kitces goes on to say that human-to-human connection provides powerful incentives to enact behavior change. As financial advisors, we serve as an “accountability partner” to our clients.
Staying the course during turbulent market fluctuations begins by communicating to clients and setting expectations before volatility happens. Knowing your clients’ behavior and keeping them informed through client reviews, phone calls, newsletters, webinars, and special commentary is central in assisting them in maintaining a long-term investment outlook.
Staying the Course
As investors, keep in mind market corrections are a normal part of the investment environment as are daily fluctuations (see chart below ).
The chart shows annual calendar year returns and intra-year declines of the S&P 500 Index from 1980-2018. The gray bars indicate the annual calendar year returns (positive or negative) ) and the red dots indicate market correction in a given year. Annual market corrections are normal occurrences which should encourage clients to stay the course during markets drops. Despite the average intra-year drops of 13.9%, annual calendar year returns where positive 29 out of the 39-years, with an annual return average of 8.4% from 1980-2018. This chart illustrates the long-term performance of the S&P 500 and shows staying invested through different market cycles is important to achieving long-term investment goals.
The key to creating wealth over time is to stick with the fundamentals and employ good asset allocation with a long-term horizon. Diversification through a strategic asset allocation in stocks and bonds around the world remains the hallmark of a portfolio that can help investors pursue their objectives in the long run. A disciplined investment approach in a diversified portfolio and regularly rebalancing over time enhances historical risk-adjusted returns. So, if you start getting nervous during severe market declines or booms, remember what Warren Buffett, one of the world’s legendary investors, said: “Be fearful when others are greedy, and be greedy when others are fearful!”