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Investor Myths about Volatility

By Mike Schnitzel April 21, 2020

This is Part 2 of Financial Advisor IQ’s five-part special report on how financial advisors can help their clients through periods of volatility.

Market swings can shake the nerves of even the most seasoned investors. They can also offer the allure of a quick buck to the boldest of day traders. In truth, markets are hard to predict and harder to time. These are some of the most common investor myths that you may hear from clients in turbulent times.

The first volatility myth that advisors commonly hear from clients is that it’s actually possible to time the market, according to Colin Drake, principal at Marin Financial Advisors.

“This is very much perpetuated by decades of Wall Street messaging,” he says. “We live in a time where it’s very easy to analyze market timers’ track records and analyze whether it is doable. Study after study comes back saying it is hard to find a market timer who consistently adds value through that skill. The stock market delivers most of its gains on about 1% of trading days, so if you miss those you miss out.”

“The market moves ahead of the news. A typical client request will be ‘Why don’t we sit out while things are ugly, and we’ll get back in when the coast looks more clear?’ The reality is that there is no call that the coast is clear.”
Colin Drake
Marin Financial Advisors
Investors or advisors who may have sold their investments in the initial days of the coronavirus pandemic-triggered volatility, or who are selling now in an attempt to time when they’ll get back in, think they can find the bottom, says Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA.

“It’s very hard to do that,” he says. “If you have a plan with a long-term horizon, you should stick with it and try not to time the market. You’re not that smart.”

Another investor myth is the ability to recognize the signs that the market has turned a corner, an ability Marin’s Drake strongly doubts.

“Many investors think somehow the market will give us a signal that the coast is clear,” he says. “Market recoveries tend to start when the news is the darkest. By the time the news is cheery, typically you’ve missed out on most of the recovery. The market moves ahead of the news. A typical client request will be ‘Why don’t we sit out while things are ugly, and we’ll get back in when the coast looks more clear?’ The reality is that there is no call that the coast is clear.”

As for the market volatility caused by the coronavirus pandemic, CFRA’s Rosenbluth agrees there won’t be “all-clear signal” from the market.

“We don’t know where the bottom is for this,” he says. “It’s possible we’ve hit it, it’s possible that we’ll turn the corner in April, but it’s also possible that there are new lows to be made.”

Rosenbluth stresses it’s unclear how quickly the economy will bounce back. He points out that investors who got out in March have already missed some of the recovery we’ve seen so far in April.

Mitchell Goldberg, president and CEO of ClientFirst Strategy, says one of the most common myths investors hold about volatility is that it simply means losing money.

“When volatility makes their investments go down, they equate them with loss,” he said. “If your definition of a good investment is, ‘It’s only good when it goes up,’ you’re not a real investor.”

Goldberg stresses that volatility is simply the ups and downs of the market, and that investors’ goals should be further afield. The real risk is for those on shorter timelines, such as those nearing retirement age. As such, Goldberg says an investor’s time horizon is the main determiner of their risk tolerance.

Another commonly-held investor myth is that attempting to time the market can improve investor returns over the longer term. The exact opposite is the case, according to Marin’s Drake.

“Numerous studies indicate that this kind of market-timing trading deteriorates investor returns compared to hanging out through thick and thin,” he says. “By trying to time the market, investors shoot themselves in the foot.”

Drake notes that Nobel laureate William Sharpe, who created the Sharpe Ratio to measure risk-adjusted performance, determined that to beat the market with timing decisions, investors need about 74% accuracy when it comes to decisions about when to enter and exit the market.

“Even most investment professionals fail to beat that threshold,” Drake says.

Next: When Staying the Course Isn’t an Option

Previous: Root Causes of Volatility and Preparing for the Unexpected

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Tags:  Investment strategies , Behavioral finance

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I Need Mo Money Apr. 21, 2020 at 09:47 AM EDT

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Very good article for these times. Nice to be reminded that we are all human and as FAs we dont have crystal balls to tell naive clients where the tops and bottoms are.