Bears and bounces and biases…oh my!

The markets dropped more than 30 per cent in March as uncertainty about the health and economic impact around COVID-19 peaked and before the economic support programs were flushed out. Investors’ portfolios participated widely in this drop and working with an investment advisor likely did not protect you from a significant decline in your portfolio.

And so many have probably wondered – does it make sense to pay more to work with a financial advisor if they can’t fully protect my portfolio?

The bottom line is that financial advice and investment advice are one component of wealth management.

Investors who work with an advisor for wealth management accumulate 3.9X more assets, after 15 years¹, than those who do not. Wealth Managers help investors accumulate wealth in four primary ways:

1. Wealth managers help investors from making typical behavioural mistakes.
2. Wealth managers know that it’s not what you make but what you keep that’s most important and by emphasizing the tax efficiency of investors’ portfolios and withdrawals, wealth managers maximize their clients’ wealth accumulation potential.
3. Wealth managers help investors develop a financial plan and stick to it.
4. Wealth managers understand that investment risk isn’t the only risk that can take a plan off-course.

Given that managing our behaviour can be the biggest challenge in times of crises, when emotions are running high, this post will focus on the role of a wealth manager as a behavioural coach.

Behavioural biases

There are many biases that cause our judgements and decision to be irrational. A few of the common behavioural biases that have an impact on investment decisions include the following:

• Availability bias is the tendency to focus on information and examples that are more vivid and believe they are more representative. During this pandemic, many of us have been consuming more news, with media focusing on the more extreme images and data to keep our attention. While these images may make investors fearful of investing, the reality is most publicly traded companies will survive this economic pause, even if earnings are significantly down over the next quarter or two. 
• Confirmation bias is the tendency to seek out or put more stock in information that confirms our existing beliefs while ignoring information that conflicts with our beliefs. For investors, this may lead to a desire to concentrate in a certain position or a decision to liquidate a position based on narrow information that aligns with their beliefs. 
• Since the pain of loss and hurt have greater impact than pleasure, we allow our aversion for pain to disproportionately influence our thinking. This is known as negativity bias. When markets are dropping, many investors have the instinct to sell to avoid seeing their investments drop lower even though it is the act of selling that converts paper loss into a realized loss.

Most decision-making is not made with careful deliberation. Rules of thumb and mental shortcuts are regularly relied on for quick decision-making during routine tasks, and since they are ingrained, these shortcuts often spill over into other decision-making processes with more significance, including the decisions around investments. 

How a wealth manager can help you

How do wealth managers help prevent investors from making typical behavioural mistakes? 

1. We follow a systematic investment plan. This can include regular contributions and systematic investing. The goal is to reduce the impact of market volatility-driven emotion in the investment process. 
2. We objectively rebalance your portfolio on a regular basis. If one portion of the portfolio is growing out of proportion to the other asset classes, we’ll trim and rebalance. This can be done systematically at regularly scheduled intervals, as well as manually. Over the long run, rebalancing will help capture gains and reduce volatility in your portfolio.
3. When the market falls, many investors are tempted to sell off and move to cash. We know that staying the course will, in the long run, lead to better returns than pulling out and trying to time re-entry. Missing just the 10 best days of the S&P500 index over the period 1994-2013 resulted in 40 per cent lower returns². We coach investors to stay the course.
4. To limit regret or loss aversion, stops can be used on a portion of investments in the portfolio. This is where there is an instruction to sell a position if it falls to a certain price point.
5. We can reframe volatility as an opportunity by using a cash deployment rule for the portfolio. For instance, if the market drops by a certain percentage, we will invest a predetermined cash balance taking advantage of low prices.
6. We help investors overcome their home-country bias and ensure that their portfolios are properly diversified.

How you can help yourself

While working with a wealth manager can go a long way in mitigating behavioural biases, it takes two to tango. There are measures you can take to help yourself overcome your own biases.

1. Your wealth manager or a trusted expert may be able to shed some light on behavioural mistakes you are making and help you devise strategies to avoid them.
2. If you are finding yourself overwhelmed by emotion, take a break. Sleep on it or give it a day or two before making an investment decision.
3. Reduce media intake – this can reduce availability bias and other biases.
4. Try and think of your future self. Really try and picture how you will be living and how the decision you make today will impact your ability to achieve your long-term goals. Thinking of your future self reinforces the long-term perspective and reduces the risk of being lured off course or reacting to short-term market moves.
5. Extend the long-term perspective. Most bull markets last six to eight years. Most bear markets last one to two years. Your investment lifetime will likely span 60 years. How important are recent market moves, either up or down, on a 60-year journey?

Visit our website if you’d like to learn more about becoming a wise behavioural investor.

Maximize your wealth. Live the life you want.

You work hard to save for the life you want. A wealth manager can help you work towards your goals not only through investing your money but through tax efficient accumulation and withdrawal of assets, financial planning to achieve better savings, creation of positive investment habits and mitigating risks to your earning potential.

This article is supplied by Joelle Hall of Hall O’Brien Wealth Counsel, an investment advisor with Richardson GMP. Hall O’Brien Wealth Counsel are experts in tax-efficient portfolios and planning. We speak your language so you feel confident in the plan we implement together.

If you have any questions about working with an advisor or how to evaluate whether you are benefiting from true wealth management, you can reach me at Joelle.Hall@RichardsonGMP.com

¹The Gamma Factor and the value of Financial Advice, Claude Montmarquette, Natalie Viennot-Briot, 2016
²Bloomberg Finance L.P., CI Investments. Calendar year returns of S&P/TSX Composite TR. As of December, 31 2018.