Behavioral Finance: Volatility Edition
Volatility can cause investors to make terrible decisions. Blackrock recently featured an ugly chart comparing the returns of every major asset class since 1992 to the returns of the average investor. Amazingly enough, over that 20-year period investors underperformed every single major asset class including inflation!
Source: Blackrock (click to enlarge)
Here is Blackrock’s take on the chart:
Volatility is often the catalyst for poor decisions at inopportune times. Amidst difficult financial times, emotional instincts often drive investors to take actions that make no rational sense but make perfect emotional sense. Psychological factors such as fear often translate into poor timing of buys and sells. Though portfolio managers expend enormous efforts making investment decisions, investors often give up these extra percentage points in poorly timed decisions.
As Blackrock points out, good investing decisions are often ruined by one poorly timed emotional decision, typically brought about by a response to volatility. Volatility often engenders fear, and fear can overwhelm the client’s rational thought process.
One of the chief benefits of a good financial advisor is preventing clients from undermining themselves when the markets are rocky. From an objective point of view, if you are fearful, it’s going to be difficult to calm the client down. I don’t have any magic ideas about how to keep calm, but you could do worse than the British WWII propaganda poster: Keep calm and carry on.
