While the long-term civic and economic impact of the COVID-19 pandemic remains to be seen, this unprecedented public health emergency has already had a profound effect on the financial markets. The combination of significant societal and financial disruption and a still-uncertain future is a formula for nervous investors and volatile markets.
But while the nature of the current crisis might be new—and the scale of the disruption historic—investors and financial professional alike can take comfort in the fact that the underlying dynamics are extremely familiar.
Market volatility is unavoidable. The key is to understand that volatility: to look at historical examples to recognize what drives it, to appreciate how investors and advisors usually react to it, and to understand how savvy investors should (and shouldn’t) respond in a crisis. Because once you understand the lay of the land, and have identified the obstacles in your path, you can set a course that will enable you to navigate this—or any—crisis and emerge safely on the other side.
Past is Prologue
There is a long and well-documented history of noteworthy crises that have sparked market disruption:
- National disasters
- Political upheavals
- Recessions and major economic downturns
- Geopolitical events
- Energy market disruptions
- Health scares
Health scares have been a particularly rich source of trouble, from HIV/Aids to Bird Flu and Swine Flu, and, more recently, with Ebola, Zika, and now the COVID-19 pandemic.
The unfortunate reality is that any extended period of economic growth is vulnerable to a downturn, and to investor overreaction. There’s an old joke that the Stock market is a “mass psychological experiment gone wrong,” but that joke is based on reality. We measure market activity with dollar signs and decimals, but difficult times remind us that psychology and emotion are at the heart of all market behavior. Understanding the role of confidence (or the lack of it) and avoiding overreaction and emotional decision-making is essential for smart investing in a crisis.
Psychology and Strategy
While individual decision-making is unavoidably influenced by personal biases and elements of human psychology, understanding how those factors translate to the larger structural scale of market behavior can give us valuable insights about investing during a crisis.
Fear, Greed and Timing
Warren Buffet once observed that so much of what drives investment decision-making boils down to either fear or greed. The key to long-term investing success is to, in his words: “…attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
That advice can be difficult to follow, given the natural instinct of investors (and some advisors) to want to stick with the group. Going against the grain doesn’t come naturally. But it can be lucrative. Early buyers during the late 2000s recession benefitted from rates of return that were dramatically higher those who were slower to buy back in.
The “Winner” Paradox
The biggest reason why fear is such a potent motivator is because the fear of losing is so powerful. No one likes to lose. But losing as a group tends to be more palatable. And being perceived as a loser while others are winning is tough for many to swallow. Which is why the urge to avoid independent failure and be a part of shared successes is often strong enough to overcome good decision-making. But while decision-making based on a fear of losing might be psychologically comforting in the near term, it’s precisely the wrong approach for long-term investing success.
The Discipline Conundrum
It’s not exactly breaking news to point out the value of disciplined investment decision-making. But discipline is hardest to maintain when times are tough. This dichotomy explains why so many smart investors and financial professionals who know the right thing to do end up failing to stick to their principles during a significant disruption.
Of note, however, is that discipline is not synonymous with inflexibility. Don’t get hung up on strategic specifics. Instead, focus on developing an overall approach. Cultivate the right mindset. If you are prepared to make decisions the right way, for the right reasons, you’ll be able to ride out any storm without sinking—and ultimately emerge with a stronger, more seaworthy vessel.
The Best Advisors
We can learn a lot about smart crisis investing by looking closer at the most successful financial professionals: those who have continued to thrive throughout market disruptions and past crises. What factors influence their decision-making, and what attributes do they share?
A Counselor Mentality
The best advisors recognize that their job is about much more than buying and selling. Advisors should be true counselors, talking to clients about market risks, as well as rewards. They should explain that these events are rare, but also inevitable.
They not only discuss how a client’s portfolio will change when that happens, but also about how the client is likely to feel about that. In other words: communicating effectively with clients to manage expectations means helping them understand not just the market, but themselves.
Prepping for Success
Ben Franklin said, “By failing to prepare, you are preparing to fail.” That ageless wisdom applies perfectly to financial professionals and big market disruptions. The best advisors are attuned to subtle indications that good times might be ending.
While there’s no way to predict a sudden catastrophe, a surprising number of disruptions can be foretold if you are paying close attention to the warning lights on the market’s “dashboard.” They not only watch those signs (employment numbers, market performance, Yield Curve inversion, the tone from the Federal Reserve), they start preparing early. Because the work you do before the crisis hits has the greatest impact. You can’t avoid every iceberg, but if you make sure everyone has a life preserver, there are enough lifeboats, and passengers know the drill, you can minimize the impact of a crisis.
Living to Learn
The best advisors recognize that their job entails not just educating clients, but also themselves. They make every attempt to stay flexible and open to new information, learning about new investment products, new approaches, and new opportunities in an ongoing effort to improve themselves, their services, and their clients’ outcomes.
An advisor who is focused exclusively on managing wealth is like a chef who only serves one type of food or meal. A great chef must come up with new recipes, discuss meal preferences, and incorporate new ingredients and techniques or he/she won’t last long.
The best advisors also help their clients build, protect and distribute wealth, ideally with a full suite of available resources to help with things like insurance policies, real estate transaction guidance, tax strategy counsel, and help with safeguarding clients’ finances, families and future.
Steady and Capable
Crises are inherently scary. The market turbulence that follows can be disruptive and disorienting. Which is why the best advisors know that long-term investing success is more about avoiding the major loss than achieving the greatest gain. They know how to leverage non-traditional asset categories like alternatives, precious metals and real estate investments during times of crisis. They stay on course, charting a way forward while ensuring clients that, while the current waters may be bumpy, smooth sailing lies ahead.
Drew Jackson, CIMA® is president of Concorde Asset Management, an SEC registered investment adviser specializing in alternative investments and seeking entrepreneurial-minded financial professionals to spur continued growth. Drew can be reached at email@example.com.
The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.