(original published April 2015, updated April 5, 2017)
The US stock market has gone up with few corrections since the 2009 bear market lows, with total gains exceeding 200%. Of course, not everyone went along for the ride. Many individual investors bailed out during the bear market, locked in losses, and never got back in. After being dominated by fear, with the overall low volatility of the past few years, this group of investors may have decided that it was now safe to jump back on the bandwagon.
This unfortunate behavior is likely due to the “ recency bias”, which is a natural human tendency that causes people to believe that recent trends will continue in the future.
While advisors understand this, the recency bias is more prevalent than most of us might think. Humans naturally seem to get lulled into thinking whatever has happened over the past few years is the “new normal”.
Compounding that, investor sentiment is usually highest when the market “seems” safe—after it has gone up for a long time. This can be the riskiest time to invest, since there have already been considerable gains.
Conversely, people naturally tend to be fearful after bear markets; however, in reality, a lot of the risk is already gone. These can be significant opportunities for long term investors, but unfortunately human emotions can naturally prevent us from taking advantage of them. Worse still, investors who don’t understand the “seasonal” nature of markets can succumb to panic and sell at the worst possible times. Unfortunately this happens to a percentage of investors during most every market cycle.
That’s where advisors are so valuable. They can be there to guide investors through the very difficult emotional landscape of market cycles.
The more education advisors can provide on market cycles and emotional tendencies, the better. Simple analogies are best. Market cycles are a lot like our seasons; while one season might be longer than normal, the next one arrives eventually. We have never skipped winter. Simple comparisons like this can help everyday investors remember these vital concepts.
It can also be helpful for advisors to put on their historian hat to help clients understand this, perhaps by sharing a very long term chart showing bull and bear cycles. Once clients can see the long-term history of markets for themselves, they can more easily understand the “seasonal” nature of the market.
So educate your clients using plain language and simple analogies. Repeat frequently to help counteract natural emotional tendencies.
Plans made during bull markets often get abandoned in bear markets. Without the benefit of expecting it in advance, investors often make these errors, which can have serious long-term repercussions. By having an advisor, your clients are already in a much better position, as they have your assistance during tough market times. The sooner advisors start to regularly coach clients, the less fallout is likely once the eventual bear market arrives, whether that’s this year or long down the road.
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