It’s well documented that investors are unduly influenced by short-term market swings. How can you address this?
To prevent investors from getting in their own way and impeding investment success, you’ll need to be a behavioural investing coach.
Advisors can act as emotional circuit breakers, mitigating clients’ tendencies to act against their best interests. Clients want advisors who provide holistic planning—financial guidance that considers their life goals. Integrating behavioural coaching may require an adjustment to your traditional approach but can increase loyalty and referrals.
Human biases can have persistent repercussions when applied to investing.
For instance, investors have historically demonstrated groupthink tendencies in bull markets, chasing the next hot investment, as well as in pullbacks, with a race to the sidelines. Market cash flows often display evidence of a widespread emotional response to short-term fluctuations, uncertainties, or news—as clearly evidenced in the U.S. bond market over the last few months.
Broadening that concept, we looked at rolling 12-month excess returns of the total world stock market versus U.S. broad bond market, illustrating that investors tend to enter and leave the market at the wrong times.
Overconfidence in one’s own abilities can also be particularly detrimental when it comes to money management. Even the most experienced and disciplined investor may be tempted to make impulsive portfolio moves, outsmart the market, or chase returns.
Others may be rashly drawn to buy or sell prematurely when hearing market predictions. Still others, overwhelmed with too much information, may be paralyzed with fear and indecision – letting inertia work against them.
Of particular recent significance, investors have exhibited a higher sensitivity to loss, rather than risk or return. Loss aversion has led many investors to leave the market at the wrong times. And many of them stay out thanks to lingering fears.
Overcoming the fear factor
With money sitting on the sidelines, investors should focus on factors they can control, such as how much they invest, their investment costs and having a solid financial plan. A roadmap encourages discipline and perspective that can help investors remain committed to their long-term investment goals and even ease back into the market despite uncertainty and volatility.
When presenting this plan, don’t discount clients’ emotional reactions. Rather, use them as another avenue for communication. Probe to find out the reasons for biased behaviour (even if some of those biases are contradictory) and guide clients with recommendations and sound reasoning.
Finally, remind clients that short-term movements of the financial markets should not dictate a long-term investment strategy. Instead, they need to maintain perspective and long-term discipline. Education and communication with clients can circumvent impulsive investing behaviours and decisions.