getTagNameMorningstarCorporate:blog/riskbehavior
Navigating Clients’ Financial Anxiety During Market Volatility
Tips for advisors to calm client stress
The scenario is all too familiar: The market takes a tumble and
clients are on the phone with their advisors, wondering what’s
happening to their money and what they can do about it. Investors may naturally fear a further drop in the markets. And
given how our minds judge probability and forecast the future, it’s
understandable that investors might want to pull out of funds. Successfully navigating these moments can be easier if advisors
understand the particular causes of financial anxiety for investors.
Instead of asking themselves if their client is doing the right thing,
they should be asking themselves, “Why is this moment happening?”
People use the recent and vivid past as a
guide. We’re hard-wired to see things that readily come to
mind as indicative of the future. For example, vivid and recent
things, like a drop in the stock market, are far more compelling than
events in the distant past (e.g., Tversky and Kahneman 1973). If you think about
it, this make perfect sense in our everyday life. If we see a car
coming straight at us, we don’t recite in our heads, “Past performance
doesn’t predict future performance. Therefore, the car is going to
swerve. I’m safe.” No, we take the recent and vivid past as a guide
for what’s going to happen next. In investing, that’s sometimes
referred to as our recency bias.
But when it comes to investing, these biases can lead us astray.
Assuming short-term market volatility is going to lead to a long-term,
permanent loss of capital isn’t useful. It’s the opposite. And, if you
see the herd going one way, that means there are opportunities in
another direction. Recency bias and herding behavior are egged on further by the
headlines and social-media doom that accompany market volatility,
making it feel more real and immediate than a carefully considered,
long-term plan that a client agreed with years ago. Advisors can have a calm, rational discussion with an anxious
client about how market instability is probably going to be overblown.
But if the client’s neighbor is screaming about how we’re all going to
lose everything, that overrides everything else. Vividness matters. People often get anxious about market volatility
in part because of that vividness. The more vivid it is, the more real
it feels. Advisors can fight vivid with vivid. Give a vivid example of other
investors who gave in to herding behavior in the last major scare and
then lost their house or their retirement. This isn't to scare
people, but to make the outcomes clear and vivid. Then give a vivid, real, personal example about the people who
stuck to their long-term plans through a scare and did really well.
The abstract is useless. It’s about how well you can visualize that
person who actually did it right.Steve Wendel
How market volatility impacts investor behavior
People watch how others
respond. There’s another cognitive bias that comes into play.
When people see how others are responding to a market event like
Brexit, often their first instinct is to react in the same way (e.g.,
Nolan et al. 2008). It’s hard to go against
social norms, and we fear social rejection if we do. As in everyday
life, it can be quite reasonable to follow the group if you don’t have
good information.
How advisors can address financial anxiety
Read the full paper "Turning Volatility
Into Positivity, Understanding Client Anxiety During Market
Swings."