While market volatility creates fear among clients, the real threat isn’t always external. Instead, it’s often investors’ inability to control their own – albeit natural – instincts that is the biggest issue.
Even the most well-constructed portfolio is no match for a client who wants to change things up every time the markets experience a bit of turbulence. Still, telling them to “stay the course” often fails, ignoring fundamental truths about not just human nature but physiology.
The human brain isn’t wired for investing – it’s built for survival, directing our instincts to react quickly to danger. In most instances, that’s good. But reacting quickly to perceived danger in the markets usually isn’t.
Advisors need to help investors have a better approach when emotions run high – one that will help them stay grounded, confident and invested. When it comes to long-term success, AQ (adversity quotient, also known as emotional resilience) is more important than IQ.
A Behaviorally Smart Approach
Behavioral investing begins with understanding how your brain can work against you. Common psychological biases that impede clients include:
- Overconfidence bias, which is overestimating your own knowledge or skills.
- Confirmation bias, which is seeking information that aligns with your own beliefs and dismissing anything else that contradicts them.
- Recency bias, which means placing a greater importance on recent events than on history and long-term trends.
This list is not exhaustive, but these biases impact most investors – and it’s up to advisors to help their clients combat them. Indeed, when clients have more self-awareness and can recognize these tendencies early, they are better equipped to build guardrails into their decision-making.
Helping them organize their assets into short-, medium- and long-term buckets, and understand how much is “enough” to live the life they want are important steps. These actions can help to ensure they don’t sacrifice the bigger picture for the small chance of hitting it big on a “would’ve, could’ve, should’ve” idea, and also support a more thoughtful and intentional decision-making process.
Our brains are hardwired for emotional decision-making. The part of our brain that triggers fear and our fight-or-flight response works much faster than the part of our brain responsible for reasoning and problem-solving. This is why investors may feel compelled to react quickly to headlines that they believe may impact their portfolios.
Our brains are hardwired for emotional decision-making.
Smart investing accounts for these reactions and leverages strategies to overcome them.
Beyond Riding It Out
It’s essential to help clients understand that diversification goes beyond simply spreading assets across different classes – it also includes diversifying investment styles. While long-term asset allocation plays a critical role in building wealth, it demands unwavering discipline over decades – not just days, weeks or months.
Incorporating multiple investment approaches, such as combining a tactical strategy with traditional asset allocation, can help cushion the impact of market downturns. The goal isn’t to beat the market at every turn, but to stay consistent and reduce the emotional toll of volatility.
By including strategies that perform well in different market conditions, advisors can help investors stay the course, avoid panic selling and make more rational decisions – especially during turbulent times.
More Relevant Than Ever
Amid today’s fast-moving headlines and heightened market volatility, emotional investing has never been a greater risk. When clients are inclined to react to spiking volatility, a behaviorally aligned investment approach can save them from making critical mistakes. The ultimate objective is to help them stay grounded when their brain is compelling them to react quickly.
Emotional investing has never been a greater risk.
By using multiple investment strategies within a portfolio, you can lower their risk and the level of exposure to different areas of the market without abandoning their long-term plan. With the right process, they won’t need to fight emotions because their portfolio will already be doing that for them.
Matthew Gaffey is President of Corbett Road Wealth Management.
