Handling Tough Conversations: Market Volatility
Use these practical talking points as part of the prevent, ask, coach strategy.
Prevent client anxiety by discussing market volatility before it happens.
- Even clients who are risk-takers can get nervous when the markets become unsettled. Take advantage of regular review meetings, phone and email communications, even your newsletter (if you provide one), to remind clients that market turmoil is an unavoidable aspect of investing. Also remind them that you've designed their portfolios to help withstand the impact of inevitable spells of market volatility.
- In certain situations, you may need to get more specific and explain the role that each asset class and sub-asset class plays—individually and together in the portfolio—to help your clients reach their goals. For instance, a bear market presents an opportunity to explain how bonds can help mitigate the risk of stocks and potentially reduce losses. Alternatively, a bull market is the time to remind them that sticking to their plans can be the best strategy for coping with unavoidable downturns.
- Explain to your clients that the financial markets have moved dramatically as long as stocks and bonds have existed. Help them understand that choosing an appropriate asset allocation, with a mix of stocks and bonds that is right for them, and then sticking to it can help deliver better investment results over the long run.
Ask questions that help reveal how clients may react to market volatility.
- Periods of market volatility can provide an opportunity to do a reality check on clients' risk tolerance. Ask them some simple questions, such as:
- Have you experienced anything like this before?
- How did you respond?
- What was the outcome of your response?
- Thoughtful questions can help you understand experiences that explain a client's current reaction. For instance, a younger client who experienced only the Great Recession of 2007–2009 may well fear downturns more than a much older client who has lived through many types of markets.
- Ask questions that will help your clients remember the investment objectives their current portfolio allocation aims to achieve. For example:
- Have your goals or circumstances changed?
- Has your risk profile changed dramatically in a way that alters your ability to withstand the ups and downs of the markets?
Coach clients to understand that panicking doesn't prevent losses. It can lock them in.
- Explain to clients who want to sell because of volatility that selling during a down market can not only guarantee at least a short-term loss but also makes it nearly impossible to know when to get back into the market. And clients that wait too long to get back into the market could end up forfeiting gains they may need to reach their financial goals.
- Let clients know that it's normal to worry when financial markets fall. The important point for them to remember is that markets have inevitably bounced back. This graphic provides a snapshot of the performance of the Dow Jones Industrial Average from 2007 to 2014, which you can use to help illustrate to clients the markets' ability to recover.
- It's common for clients to conflate market volatility with an inability to achieve financial goals. Of course, those in or near retirement may, indeed, be adversely affected by an extreme or extended market downturn. However, for many, helping them understand the difference between required and desired returns may reduce their anxiety.
Use these simple stories to make key points about market volatility.
Resist the temptation to react
Sometimes, the best reaction is no action at all.
To help clients understand this, consider a soccer analogy.
During a penalty kick, a soccer goalie must make a split-second decision to stay put in the center of the goal, jump left, or jump right.
Behavioral economist Ofer Azar collected data on more than 300 goalies and discovered that goalies who jumped left stopped just 14.2% of the shots, those who jumped right stopped a mere 12.6%. But goalies who stayed put in the center of the goal were able to prevent goals 33.3% of the time. Amazingly, only 6% of the goalies chose that option.*
Azar interviewed the goalies about their decisions and found that emotions played an important role. The goalies revealed that they felt worse if the goal was made and they were standing still. In fact, taking action, even if it's certain to lead to failure, was considered better than taking no action at all.
Azar applied his soccer research to the behavior of investors and found that when the markets are in turmoil, we have a powerful urge to "do something" even when that "something" doesn't make a lot of practical sense. In the 2008 market meltdown, many investors gave in to the instinct to sell because it satisfied their desire for action. But those who stayed put benefited in the long run as the market recovered.
The bottom line: During times of market stress, it can be difficult and even seem counterintuitive to stay put, but that's often exactly the best decision. Historically, the stock market delivers far more often than not. Working together, we can increase the chances for investment success by resisting the temptation to "jump" to one side or the other when markets erupt in turmoil.
* Wray Herbert, 2010. "On Second Thought: Outsmarting Your Mind's Hard-Wired Habits." New York: Broadway Paperbacks.
Tune out the noise
Noise-canceling headphones allow music lovers to enjoy listening to their favorite tunes, blissfully unaware of any commotion around them. They can also help clients become better investors.
The financial markets are a noisy spectacle. A generation ago, however, the noise was faint—a whisper from the stock tables in the daily newspaper or a weekly word of wisdom delivered in Louis Rukeyser's baritone on public television.
Today, the noise comes at us in surround sound, the volume jacked up to 11. The 24/7 cycle of news and punditry can trigger a primitive fear response in some clients that undermines their ability to stick with a long-term investment program.
In Your Money & Your Brain, author Jason Zweig explains that the scary words and images of risk that accompany many stock-market reports can set off the amygdala, a part of the brain that “acts as an alarm system—generating hot, fast emotions like fear and anger that it shoots up to the reflective brain like warning flares.¹
A television broadcast from the floor of the stock exchange on a bad trading day, for example, combines a multitude of clues that can fire up the amygdala: flashing lights, clanging bells, hollering voices, alarming words, people gesturing wildly," Zweig explains.²
If a client seems to call every time a bearish pundit growls on TV, help them understand how financial media may activate a primitive part of their brains meant to get them to run from real threats like saber-toothed tigers.
Of course, while staying course makes sense most of the time, a client may need to change an allocation if a goal or life circumstance has changed. But unless that’s the case, tell clients that you’ve learned to put on your noise-cancelling headphones to tune out the media noise. You may even want to hand them a pair of their own.
¹ Zweig, Jason, 2007. Your Money & Your Brain. New York: Simon & Schuster, p. 159.
² Ibid., p. 162
Ride the wave
When you're swimming at the beach, what do you do when a big wave comes? Head for shore, only to risk having the wave clobber you from behind? Or face the giant surge and duck under it?
If you’ve tried both, you probably know that it’s safer to dive into the wave and swim under the turbulence.
The same is true in financial markets. Selling in the middle of a market downturn clobbers portfolios. Riding market waves can lead to a smoother long-term ride.
When stock prices fall, clients often fixate on their losses and wonder whether they should sell. To help them see that over the long run, stocks move upward, try teaching them about the zoom theory.
So what's the zoom theory? It's a mental version of those zoom tools on the web. It works like this: Clients are susceptible to what behavioral finance experts call "recency bias," the tendency to overweight recent experiences when forming a view of the future. That's why they say they can tolerate risk when returns are strong, only to ask if they should sell when asset prices fall. They zoom in.
Teach them to zoom out by showing them how, over longer time periods, weathering short-term declines can help their portfolios grow.
Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
Past performance is no guarantee of future returns.