Volatility may drive anxiety as market fluctuations are part of our not-yet history…. At the beginning of the pandemic, there was daily volatility (a market change of nearly 10%) as well as longer term volatility. Investors sometimes equate volatility with recessions. More recently, they may link the pandemic volatility to increased inflation.
Many in the industry have been assessing what could be ushered in with the new administration in 2025. Some are making predictions based on changes in personnel, others based on the changed regulatory structure. But one thing is for certain: the market may be volatile once again. It certainly has in the post-election time. We thought it could be helpful to think of how to respond to client concerns in a volatile market.
As a field of study, behavioral science lags behind geology and chemistry in longevity (it emerged in the 1980s), but may be more practical, especially when dealing with retirement planning in volatile markets.[1] Behavioral science as applied to the field of finance, called Behavioral Finance, helps explain how and why investors react to the market and each other. There are three key elements to behavioral finance on which advisors can rely: 1) investors make most of their decisions using shortcuts; 2) investors filter information through a set narrative; and 3) these limits make the market inefficient. Of these three rules, the first, concerning shortcuts may have the most impact when dealing with volatility. The theory of bounded rationality holds that when an investor makes a decision, they are limited in their rationality by outside constraints, such as time or social constructs. This drives investors to make suboptimal decisions by taking shortcuts. Emotionality is one of the drivers of suboptimal shortcuts, in that investors may want to reduce anxiety by taking action to lessen perceived negative possibilities. In short, when scared, investors want out. An advisor can help clients by making clear how taking short cuts will cut short their client’s retirement funds. For example, providing charts or case studies depicting multiple scenarios can help clients avoid this mistake.
Volatility may drive anxiety as market fluctuations are part of our not-yet history. What exactly is volatility? Investopedia defines it as “a statistical measure of the dispersion of returns for a given security or market index.”[2] As it applies to the stock market, volatility “is often associated with big swings in either direction” usually more than 1% over time. At the beginning of the pandemic, there was daily volatility (a market change of nearly 10%) as well as longer term volatility. Investors sometimes equate volatility with recessions. More recently, they may link the pandemic volatility to increased inflation. Advisors may find the second of the three keys to behavior finance, involving filtering information through a narrative, applies to this new round of volatility. By making those narratives explicit, an advisor may be able to help clients remove the association between volatility and inflation.
Setting aside behavior finance, advisors may find that simple psychology concerning how to address stress can be helpful. Even the colors advisors use to communicate to clients can help reduce anxiety.[3] Most web design is aimed towards capturing and retaining a reader’s attention. That often includes strong contrasts and primary colors (red, yellow, and blue). Punching colors up adds vibrancy and energy (imagine moving from navy blue to tiffany teal) as well as a sense of immediacy and action. But clients may not need extra energy when considering their retirement investments at the moment (or for the next several moments for that matter). And, as noted above, urgency may lead to suboptimal decision-making. An alternative idea may be to soften both color and contrast. That could mean choosing alternate colors, as well as fewer of them. It could also mean monochromatic design, which would involve two shades of the same color (forest and leaf green, for example).
[1] https://www.bcgbenefits.com/blog/behavioral-science
[2] https://www.investopedia.com/terms/v/volatility.asp
[3] https://www.bcgbenefits.com/blog/color-me-calm
These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.
Before leaping into the unknown, we recommend a thorough examination of your plan. Because we are experts in the field, we know the marketplace and know what your existing vendor is capable of offering. Through this examination, we can help you optimize the service you receive.
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