When market fluctuations are paired with rumors of hydrogen bomb testing in North Korea, the recent acts of domestic terrorism and a long-in-the-tooth bull market, it can all be a little frightening and overwhelming.
It’s at a time like this that it’s best to temper the catastrophic voices in our head with some research-based truths about how financial markets work.
For each of the rash, fear-induced common thoughts clients may have (below in bold), advisers can offer a counter argument fueled with a dose of realism:
“It’s been a good run, but it’s time to get out.”
From 1926 to 1997, the worst market outcome at any one year was pretty scary, -43.3 percent; but consider how time changes the equation—the worst return of any 25-year period was 5.9 percent annualized. Take it from the Rolling Stones: “Time is on my side, yes it is.”
“I can’t just stand here!”
In his book, What Investors Really Want, behavioral economist Meir Statman cites research from Sweden showing that the heaviest traders lose 4 percent of their account value each year. Across 19 major stock exchanges, investors who made frequent changes trailed buy-and-hold investors by 1.5 percent a year. Your New Year’s resolution may be to be more active in 2016, but that shouldn’t apply to the market.
“If I time this just right…”
As Ben Carlson relates in A Wealth of Common Sense, “A study performed by the Federal Reserve…looked at mutual fund inflows and outflows over nearly 30 years from 1984 to 2012. Predictably, they found that most investors poured money into the markets after large gains and pulled money out after sustaining losses—a buy high, sell low debacle of a strategy.” Everyone knows to buy low and sell high, but very few put it into practice. Will you?
“I don’t want to bother my adviser.”
Vanguard’s Advisor’s Alpha study did an excellent job of quantifying the value added (in basis points) of many of the common activities performed by an adviser, and the results may surprise you. They found that the greatest value provided by an adviser was behavioral coaching, which added 150 bps per year, far greater than any other activity. At times like this is why investors have advisers so don’t be afraid to call them for advice and support.
“THIS IS THE END OF THE WORLD!”
Since 1928, the U.S. economy has been in recession about 20% of the time and has still managed to compound wealth at a dramatic clip. What’s more, we have never gone more than ten years at any time without at least one recession. Now, we are not currently in a recession, but you could expect between 10 and 15 in your lifetime. The sooner you can reconcile yourself to the inevitability of volatility, the faster you will be able to take advantage of all the good that markets do.
This post originally appeared in the Brinker Capital blog. It is intended for informational purposes only. The views expressed are those of Dr. Daniel Crosby and are not intended as investment advice or a recommendation. The Center for Outcomes is a subsidiary of Brinker Capital. Brinker Capital and Nocturne Capital are not affiliated. You can find more of Crosby’s work on remaining calm in scary times here.
Editor’s Note: Dr. Daniel Crosby will be leading a session on behavioral finance at this year’s FPA Retreat at the Wigwam Resort in Phoenix, Ariz. His session will take place at 9:55 a.m., Thursday April 28. To register for FPA Retreat, click here.
You may also be interested in the following related FPA content:
- The March 2016 10 Questions interview in the Journal of Financial Planning with Andrew Lo of MIT, who discusses volatility, trend following and why financial advice is incomplete.
- The FPA Practice Management blog post, “Advising Clients During Turbulent Markets” by Victor Ricciardi and H. Kent Baker.
- This research, titled “Understanding Behavioral Aspects of Financial Planning and Investing,” also by Victor Ricciardi and H. Kent Baker, which was published in the March 2015 issue of the Journal of Financial Planning.