Markets & Economy
Market volatility and your emotions
May 23, 2014
Rebecca Katz: Our next question is from Zunaid in Birmingham, Alabama, who says, "Do I invest more in down markets, or should I let dollar-cost averaging do the work?" So, Chris, I'll turn to you since we've touched on this a little bit. But you've said, don't worry about—don't overthink when the markets are going up. I assume it's the same when markets are going down?
Chris Philips: Yeah, I think that the nature—and this is going to go back to our discussion on rebalancing—is that the nature of rebalancing means that you are buying the depreciated asset. So you're selling the winners and you're buying the losers, if you're making an effective rebalancing program over time. I think that one of the challenges, again, of buying when the market is down is it's great in theory, but it requires pretty good execution over time to be truly effective. If we can always pick the peaks and the troughs to actually make those moves, then that would be ideal, but no one can really do that effectively over time.
If the market does have a down year, like 2008, absolutely that can be a good time to buy. However, it's never that cut and dry, because in the moment is when discipline—and our fourth pillar—really needs to take hold, because the urge in the moment is to get out. When Lehman Brothers is going bankrupt, when AIG is going bankrupt, when you have all these financial institutions going down, and we hear nothing but doomsday scenarios from the market pundits, very, very few investors have the wherewithal to actually go in and buy. And the huge hunch is that behavioral component.
The other component is, hypothetically, what if you are in a Great Depression type of scenario, and I don't want to be a doomsayer here, but that market went down 40% and it went down another 50%. So if you had bought at 40%, now you're down another 50%. So it's never as cut and dry going forward, even though history looks very, very transparent and easy to map.
Rebecca Katz: Your group has actually done some research around this sort of behavioral coaching and the fact that having an investment advisor to keep you from, when the market goes down, pulling your money out, actually can add a lot of value. Do you want to talk about that a little bit?
Chris Philips: Sure. We actually view the singular most influential benefit of a financial advisor, whether it's a one-off financial plan or an ongoing advisor to a portfolio, is that behavioral coaching. Having low-cost funds, doing asset location, that's all very important, but it can also be fairly lumpy. So asset location might not give you a benefit year after year after year; it might aggregate in one year, and then not show up for a number of years. That behavioral coaching is critical.
And that 150 basis points, the 1.5% I mentioned earlier on, that was one of the outputs of this study that we looked at for the benefit that an advisor can have. And we summed it up by saying it's around 3% or so, the benefit of an advisor. But I think it is also critical to understand that's not extra return the investor might get. It's that the average investor, if they don't do these things, they're operating on their own, can actually lag the markets by up to 3%. The advisor can actually close that gap and get you back to what the markets might be giving you in an idealistic state.
Rebecca Katz: Our next question is from Warren in St. Louis. And he says, "How should you deal with market volatility?" We've touched on this quite a bit. But the reality is, you can listen to the radio all day long and it's telling you the Dow is down, the Dow is down, the Dow is down. What do you do about that?
Chris Philips: The best approach is to try and maintain that discipline over time. And if you have effectively implemented an asset allocation over time and you have a mixture of assets—stocks, bonds, cash if it's relevant—the volatility that you hear from the news, the volatility that you see, is probably going to actually be less impacted in your portfolio. And why I say that is, if we hear that the Dow is down 3% in a day, most investors aren't allocated 100% to stocks. So they already have some dampening impact by having some of their allocation in bonds and cash, which probably aren't doing much that day, because they don't move a lot in a day. But that right there should be a comfort because you're not down 3%, you might be down 2% or less. And it's still not optimal, but the volatility that we see in the marketplace isn't reflected in most investors' portfolios.
Then if we additionally take a big step back and maintain that discipline over time, we can try and just think about the long term and acknowledge that yes, markets are volatile, they need to be volatile in order to generate returns over the long term, that's just the nature of investing. Let's try not to react in the moment to those poor events.
Rebecca Katz: It's interesting, and they're probably watching, but my parents are getting close to retirement age, and they listen to the radio too and say "Oh, the market was down today." And I keep saying, "Don't worry about it, don't worry about it." But it really is hard emotionally, especially if you are close to retirement, to deal with that volatility. Do you actually see your clients make changes? I know our phones light up when the markets are down significantly, or up significantly. What do people actually do?
Kahlilah Dowe: Going back to what you said about investors coming up on retirement, I think they tend to get a little scared, because you have this vision of retirement, and you don't think that—and I think a lot of investors kind of have 2008 looming over them—so will this be the next 2008? So when we see that the Dow is down significantly, I think it automatically brings up those memories. And so a lot of our investors call in and they just want to hear us say, "Everything's okay."
But one of the things I tell the clients that I work with is that volatility in the stock market is not unusual; it's actually quite normal. So going back to what Chris said, this is why we expect the returns that we expect from stocks; they have to be, or they're supposed to be, volatile like that. It's just the nature of the market.
But I think the other thing is most investors don't look at the bottom line on the portfolio. They don't look at where stocks and bonds are. They say the stock portion of my portfolio is down X%. And so one of the things that I do is kind of bring them back to the fact that this is why you have bonds in the portfolio. This is why they work together.
All investing is subject to risk, including the possible loss of the money you invest.
For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling. You should consider whether you would be willing to continue investing during a long downturn in the market, because dollar-cost averaging involves making continuous investments regardless of fluctuating price levels.
There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
Advice services are provided by Vanguard Advisers Inc., a registered investment advisor.
This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.
© 2014 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.
How to maintain a steady hand with your portfolio
It may be difficult to keep your emotions in check during market gyrations, but research shows that a steady hand may reap financial benefits. Vanguard investment experts Chris Philips and Kahlilah Dowe say that a financial advisor can be an effective behavioral coach to help you make sound decisions.
Other highlights from this webcast:
- Four pillars for investing success
- Asset allocation and rebalancing
- Can I keep my assets in my 401(k) after I retire?
- All investing is subject to risk, including the possible loss of the money you invest.
- For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
- Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling. You should consider whether you would be willing to continue investing during a long downturn in the market, because dollar-cost averaging involves making continuous investments regardless of fluctuating price levels.
- There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
- Advice services are provided by Vanguard Advisers Inc., a registered investment advisor.
- This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.