Rocky markets that leave investors racing for the sell button also give advisors an opportunity to deepen client relationships and discourage emotion-driven moves, Morningstar suggests in a recent paper.
Stay-the-course investing discipline is often difficult because the instincts that are generally beneficial don't serve stock market investors well, notes the report, which seeks to help advisors understand client anxiety over volatility and transform it into a positive experience.
“To put it simply, our minds were not hard-wired to think long term. For millennia, our key goal was present-day survival,” Samantha Lamas, Morningstar senior behavioral researcher, said in the report. “Unfortunately, many of the decision-making shortcuts that have served us in that goal, aren’t optimal for investing.”
An advisor's role as behavioral coach "plays an essential role in helping clients avoid making emotion-driven investing mistakes," she said.
The report outlines mechanisms behind client anxiety in market drops and offers advice for addressing them, citing recency bias and herd behavior as major factors.
Recency bias is the belief that recent, vivid events will probably continue, the report notes. And because people are social creatures, investors are tempted to follow the herd.
"Recency bias is interesting because it helps us do the right thing in life-or-death situations and the wrong thing in investing. ... If you see a big market sell-off, recency bias tells you it’s going to keep losing value so you should get out,” Morningstar behavioral scientist Danielle Labotka said. “But that’s the exact opposite of what you should do when investing."
This trait and herding behavior are magnified by "doomsaying" headlines and social media posts, the report adds, noting that advisors can turn these instincts around when it comes to investing moves, Morningstar says.
“Concrete examples are going to carry more weight than anything when clients are scared. Something they’re afraid of is right in front of them, so you need to show them why they should listen to you instead,“ Labotka said.
“This can mean giving honest examples you’ve seen of people who have deserted their plans when markets got rough and compare them to those who stuck with them. This can also mean showing them projections of what can happen to their portfolios if they run now versus if they stay put,” she explained. “Fear is a tangible emotion, so you need to ensure your clients see and feel the benefits of listening to your advice.”
Labotka also suggested pointing out that market contrarians like Warren Buffett see downturns as great buying opportunities.
Beyond urging clients to turn off market coverage, advisors should show them how their portfolio is progressing toward meeting their goals, according to the report.
“Goals should always be what you bring it back to, so when clients call panicked about the market, they walk away assured that their financial plan will help them reach their goals," Labotka said.
Lamas suggested that advisors, before market downturns arrive, have clients write self-addressed letters outlining their strategic reasons for choosing their long-term strategy.
“This tactic is about preparing your client for market volatility," she said in the report. "As a bonus, ask your client to give their future self advice on what to do if they are tempted to react to market volatility. Now when your client calls you panicked, this letter can be used as a tool. Where the client can read, in their own words, why they shouldn’t make a rash decision.”
As for the clients who don't call, Morningstar recommends that financial pros either check in with them or maintain a social media presence as a reminder that their advisors are available. Being available and helping clients through market volatility can build on relationships with them, Morningstar notes.
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