Many of us are aware of the stock market volatility we’ve experienced thus far in 2016, with the Dow Jones Industrial Average dropping -10% from January 1st to February 11th. On the positive side, in the two weeks since then, we’ve experienced the attractive side of volatility, with a bounce back of +6% (as of Monday, February 29th.)
As our team follows the investment markets each day, the write up in this link caught my eye, “Emotional Selling Has Nearly Tripled So Far This Year.” Interestingly, we have not seen emotional selling this year among our clients, although, not surprisingly, we have heard questions and concerns expressed about the direction of the markets.
I think it is useful, though, to consider the specifics that drive emotional selling since market downturns can be so unnerving.
Two weeks ago, I attended a presentation on this topic and found the comments on the operation of the brain during these market periods interesting. To wit:
The mind is built to take short cuts. It is a pattern-detecting machine. If a person hears negative news several times, the brain will give that more weight than other information received less frequently. If we put this together with the media – which is seeking viewers and, therefore, motivated to sensationalize matters – we might to ask ourselves: Will the population tend to hear balanced comments more often, or sensationalized ones? What patterns will our minds tend to detect and then gravitate toward?
The mind dislikes uncertainty. Even negative outlooks are preferred rather than dealing with uncertainty. An outlook, of any sort, will help the mind plan for the future, which the minds' executive function is structured to do.
When something threatening or scary occurs (such as investment accounts declining in concert with bad news from the media), the amygdala section of the brain sets off the “Flee to safety!” alarm. The amygdala also serves as the “gas pedal of the brain.” When stimulated, it highjacks the prefrontal cortex – where the ability to think and self-control reside – with an override command of “Do something!”
Given the above predispositions of the brain, we can see why there has been some emotional selling as of late. Yet we know that such untimely selling can be financially imprudent. It tends in the direction of selling when valuations are low, and then buying back in when valuations are higher (if one buys back at all). This is certainly not a successful investing methodology. Therefore, we can conclude that the urge to sell must be strong.
The speaker pointed out that our brain’s reactions are both involuntary and physiological. They’re an ingrained part of who we are. The speaker joked, “As investment professionals, you could try to get yourselves and your clients to be unemotional investors, but then you’d all have to give up your brains!” On the lighter side, this comment made me think of one of my son, John’s (19 years old) favorite shows, The Walking Dead – yes, it’s about zombies. I’ve occasionally watched the show with him, and I must say that I prefer all of us just the way we are, brains fully intact!
An even better question may be: "Why/how have others resisted the urge to sell during these volatile times?
I’ve been doing this work for thirty-three years and learn every day. That said, here’s my list of some the secrets of “not selling during inopportune times”:
First, it’s very important to choose an investment risk/reward strategy that truly suits our preferences regarding risk (and reward). Most of us have a sense if we are conservative or more aggressive investors.
Once we’ve settled on a strategy we think we can “live with,” then it’s important to train our brains to perceive negative news, and even “down” account values, as an opportunity to buy at bargain prices, and do the converse in markets that are appreciating. Of course, balance is important in this. We should not be so active in this that we lose proper diversification.
By retaining us, you've chosen to have access to a balanced source of information. Given the pattern-detecting nature of the brain combined with the incentives of our media, knowledgeable, unbiased input can make a real difference.
Investments are just a tool to get something done in life. For that reason, we much prefer to work with our clients holistically, i.e., on what they’d like their investments to do for them. If we are helping with all of the pieces, during a downturn we can say, “Even now, you have a sound financial plan.”
Can we quantify the value of not falling prey to emotionally-based investing decisions?
Last year, Vanguard released a 14-year study1citing that, “Guidance when investors needed it most,” along with expert wealth management, added about 3% per year of financial benefits for investors, after all fees, as compared to the results of “do-it-your-self (DIY) investors.” Of course, not all DIY investors base their investment decisions on emotions or bad news. However, the conclusions of this study are especially compelling coming from Vanguard because this firm is often considered the largest platform for DIY investors.
After the six-year upswing (2009 to 2014) in the equity markets, we do expect a level of volatility to continue, and as suitable, have recommended portfolio adjustments accordingly. That said, money can be made during these times. Opportunities may be presented to pick up bargains. Our outlook is not for a recession or bear market in the near future. The strength of consumer spending combined with low U.S. unemployment suggest otherwise, but of course, new developments can always occur. For this reason, maintaining the elements in your portfolio that offer downside protection in declining markets continues to be important. Please call us with any questions about your portfolio.
As I think back for a moment to zombies, I’m quite certain they would not handle investments and financial tools wisely (at least not the ones I was watching!)
However, being thoughtful and purposeful, even during trying times, can often lead to a positive place. It is fulfilling to see this occurring among the clients we serve.
We always enjoy hearing from you.