Written by: Ryan Scott
In early July, the US markets declined 2%; the largest one-day market dip in the last two years. It was Greece, this time, which left a bad taste in investors’ mouths and proved to us once again that the markets don’t always steadily increase over time. It seemed like a bad day for investors and a bad day for advisors.
And right now, the market volatility continues! On bad market days, advisors may be overwhelmed by their client’s emotional responses to the market movements. How can you be pro-active and gauge the "market mood" of your clients?
Below is a 4-step market volatility plan to prevent market dips from disrupting your day.
1. Lay the ground work with clients on loss aversion to open up discussions:
We all know that people hate losses, but research originally conducted by Daniel Kahneman and more recently by the AARP quantifies this level of hate. Their research indicates that an average person is 2 times more averse to losses compared to their value of gains, and retirees are 5 times more averse to losses than their value of gains.
While this fact is interesting, the “average” person is never sitting across the table from an advisor. In fact, our research indicates that only 38% of people have what the AARP study describes as normal levels of risk (e.g. Group 4 of 7) and the 2:1 ratio introduced by the research can be as high as 10:1 for the most conservative investors. To zero in on the exact level of pain or pleasure shown the graph above, advisors have to objectively measure the level of loss aversion by a validated instrument. Once this level of loss aversion is uncovered, a conversation needs to be had with the client (and their spouse). The goal of this loss aversion discussion is to identify the gut reactions clients experience with losses and identify what level of exposure they can tolerate to market volatility.
2. Develop a Market Volatility Plan (MVP):
A 2% dip in the market is a fearful event for some clients, but an opportunity for others. Objectively segmenting clients into these groups allows advisors to better prepare for their discussions by knowing how the client will look at the market scenario (either with a positive or negative outlook). One solution, Market Mood, will segment clients automatically by the level of market fear and prioritize advisors’ working days. If an advisor doesn’t have Market Mood, this could also be done manually once you have developed an understanding on the following behavioral finance principles:
a. Most clients that have more aggressive risk profiles look at small market declines with optimism, in hopes of making a return on the current market volatility. The key for advisors is to allow the client to make investment decisions rationally by appropriately presenting the risks and rewards.
b. Most clients that have conservative risk profiles make irrational decisions when they are losing money. These people require attention immediately or their emotions will get the best of them.
3. Identify the Communication style of your clients:
Clients understand and retain the most information about market events when they are approached with their preferred communication and learning style. It’s critically important that the client’s preferred communication style is documented and available to each client-facing representative in a firm.
a. Introverted clients prefer to be contacted via email
b. Extroverted clients like to meet in person
c. Fast-paced clients like to get to the point with a phone call
d. Patient clients like to keep discussions calm
4. Document and manage your client’s behavioral biases:
Behavioral biases are the blind-spot of investing. When confronted with new investing situations, clients will inherently let their biases drive their decision-making processes. The key to managing your client’s decisions in volatile markets is to first identify and document a client’s biases and train your staff to look out for the warning signs.
I am a creative person. The struggle with people like me is that they become easily bored and have the desire to constantly “re-invent the wheel”. In Behavioral Finance, we call this a Newness Bias. Just like a Doctor would document someone’s hypertension or diabetes on their medical records, advisors need to have client “conditions” documented. I am likely to call my advisor trying to de-rail the train from our existing plan because the market made a quick dip, having these details documented, allow the advisory staff to help steer the train back onto the tracks.
Execute on your action items
Once the Market Volatility Plan is created, all you need to do is execute!