In my conversations with advisors, I often hear how much they dread market volatility. The idea of political turmoil, a looming recession or (even worse) an extended bear market quickly becomes the anxiety-driven theme of the discussion. These events are painful, and it is a good thing that they don’t happen very often. But few advisors consider that without the fundamental uncertainty of the markets, they wouldn’t have a job!
The human brain is essentially a prediction machine. It is designed to consume information from experiences in the environment, interpret it and then use it to try to predict the future. This process evolved over millions of years to ensure humans’ survival and prosperity in a hostile ecology.
Evolution not only gave us this obsession with predicting the future; it also supplied us with a huge number of built-in mental shortcuts to help us cope with all that hostility. Behavioral scientists call them heuristics: decision-making patterns that are built in to our brains and operate outside of our awareness. Researchers have discovered and defined more than 180 different heuristics.1
So not only does everyone worry about what’s to come and want to take actions to make their personal future safe and secure, but they also react with predictable intensity to threatening circumstances. These reactions are more irrational and instinctive than they are logical and deliberate, for the sake of speed. Heuristics are shortcuts that enable us to react quickly and efficiently when faced with a threat.
Our instinctive reactions are amazingly efficient. If we accidently touch a burning-hot stove, we jerk our hand away before we feel pain. If we are startled, our brain sends adrenaline into our bloodstream to prepare for action before we even know what the threat is. Our bodies are hardwired to react instantaneously.
Many of these reactions are not physical; they operate inside the decision-making processes in our brain. For example, when we have money to invest, we often prefer companies that are familiar. Known as availability bias, this heuristic is the tendency to simplify a decision by using the most immediately available information.
If we made an investment that lost money, we naturally feel an intense need to sell it. This is called loss aversion. Researchers have discovered that losses feel much more painful than gains feel pleasurable, and they’ve found the same pattern around the world. Human beings innately react in some very irrational ways.
What Does This Have to Do with Being a Financial Advisor?
If we stitch these ideas together, we realize that the role of the financial advisor is necessary because markets can be volatile, people are obsessed with an uncertain future and we are hardwired to make nonrational decisions. If the future were totally predictable, risk would not exist and investing would be different (and much less difficult). It would be easy, like fishing in a recently stocked stream. No one would need the services of a guide.
If humans inherently made solid, highly rational decisions based on all available information, everyone could learn how to invest despite the uncertainty of the future. Because our brains aren’t designed to think statistically, we need expert help. And because the future is not knowable and markets are volatile, the services of an advisor are—for most successful people—not just a good idea but an essential resource.
Rather than wish for benign markets, the prudent advisor celebrates the challenges that investing represents to the average brain. She becomes familiar with the multiple ways in which clients struggle with their built-in mental shortcuts. Savvy advisors build a Standard of Care that focuses on discovering what clients want in their future, then connects an asset-management model to that vision.
Importantly, the prudent advisor understands that it is in times of volatility that her professional skill will be most valuable. The abilities to respond thoughtfully, provide calming interpretations and conduct supportive conversations restore clients’ confidence in the future. This fulfills the vital role the advisor was hired to accomplish.
For more on becoming better at managing client relationships in volatile markets, register for our next practice-management webcast on November 12.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
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