On average, stock markets experience a correction every 357 days, approximately once per year. According to investment firm Deutsche Bank, the last major market decline prior to the correction during the week of August 17 was nearly 1,000 days ago, the third-longest streak on record. History has shown that corrections are an inevitable part of stock ownership, and financial advisors and their clients can do nothing to stop a correction from occurring.
Financial advisors often spend a lot of time trying to calm even the most seasoned clients when events such as the recent Chinese market downturn temporarily shook global markets and triggered a crisis of confidence among investors.
I will say up front that careful planning and a disciplined investment approach can blunt the long-term negative effects of all but the worst market corrections. Advisors who diversify their clients across various asset classes that reflect their goals stand a good chance of ducking the crashing crest of a correction wave. However, investors still get spooked when their asset values decline and feverishly track their ebbs and flows each morning.
Advisors who help clients manage their fears using a combination of empathy, professional objectivity, and historical data enhance their trust in them.
For clients, this is an emotional time full of uncertainty. Many advisors agree that the emotional intensity of declining investment values far exceeds the emotional intensity of large increases.
Here are seven insights advisors can share to ease their clients’ anxiety during a market correction.
#1: No one can predict what will cause a market correction and when it will occur. Nor can they predict a government’s response to a crisis. For example, the recent global market correction was triggered by China’s “Black Monday” that quickly wiped out hundreds of millions of dollars from the world’s financial markets.
Think back to the dark days of 2008’s November lows when 12 of Bay Street’s best recently put their economic forecasting skills to the test by betting that the Bank of Canada Governor Mark Carney would cut the overnight lending rate again in early June, to below three per cent. To their surprise, he did not and kept rates steady. Consider offering the adage that even though it has feathers, a bill, and takes to the water, it is not necessarily a duck.
#2: Corrections never last long. Between 1945 and 2013, the average correction lasted 14 weeks. Investors who leave the markets often suffer in the long term. History has shown that stock markets rebound in advance of the economy. The S&P 500 rebounded significantly before the first quarter of positive economic growth (measured by Gross Domestic Product) following the 1980 and 1990-1991 recessions.
#3: Stock market corrections negatively affect short-term traders more than other investors who have long-term goals and invest patiently to reach their retirement goals. Corrections also hurt investors who are highly leveraged or trade on margin, which can be damaging to your financial health in a sudden, sharp downturn.
#4: The market timers’ hall of fame will always be empty. Staying the course and following your long-term plan is better than fleeing to the sidelines or sporadically moving in and out of investments. Investors who dumped their portfolio holdings during the downturn of 2008-2009 exposed themselves to equity losses without benefiting in the market recovery that followed. Vanguard research noted that a buy-and-hold approach outperformed a performance-chasing strategy by an average of 2.8% a year during the 10-year period in question.
#5: Downturns can create great buying opportunities for investors who are well-diversified and want to invest at a discount in the hope their prices will rise. A correction can provide investors with the opportunity to re-assess their portfolios and ask themselves why they originally invested in an asset class and whether those investments still reflect their long-term investment strategies. It’s a good time for advisors to sit with clients and revisit some foundations of smart investing:
- Diversification reduces uncertainty: Concentrated investments add risk with no additional expected return.
- Risk and return are related: Exposure to meaningful risk factors determines your expected return.
- Asset allocation drives the return of a broadly diversified portfolio: Individual stock picking, market timing or manager or industry selection negatively influence expected returns.
#6: Encourage clients to remove emotion from investing. Have them avoid looking at their portfolio’s value daily and remember that the media is looking for a story that will attract and engage viewers. They need to be careful not confuse entertainment with advice. The financial media’s message can compromise an inexperienced investor’s long-term focus and discipline, and lead to poor investment decisions. If necessary, encourage them to turn off the business channels and go to ESPN.
#7: Reach out to clients. You needn’t barrage them with technical data, but offer them a short fact sheet about what is happening and what you are doing to help protect – and grow – your clients’ assets during a market correction. Most importantly, make yourself accessible and be there to take their calls. A proactive approach involving contacting them by email with useful information can save them time in getting the answers they need before picking up the phone.
This article was originally posted on LinkedIn.
