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A Fiduciary Must Confront The Fears and Fads of Market Cycles

A Fiduciary Must Confront The Fears and Fads of Market Cycles
June 11
00:07 2019

Despite the recent market undulations experienced in the last 6 months, we are on the cusp of a record-breaking bull market run. During late bull markets, investors begin using a different calculus in search of greater returns. It’s quite the opposite from the way they think during market lows. A fiduciary must navigate through the fears and fads of these treacherous extremes.

Why, for example, would investors flee falling markets just as valuations become attractive? “That’s easy,” says Holmes Osborne of Osborne Global Investors, Santa Monica, California, “they’ve lost money and don’t want to lose more.”

Why are they so quick to ignore Warren Buffett sage advice to “buy when others are fearful”? Jeffrey A. Miller, President and Portfolio Manager of NewArc Investments, Inc.in Naperville, Illinois, says, “At market lows, investors are fearful and moving out of stocks. Many studies have shown consistent behavior of buying high and selling low.”

Imagine the reaction of a typical 401k saver. Their goal is usually long-term – saving for retirement. Yet, right at the moment when they’re poised to do the best for themselves, they take their eye off the ball. “When the market pulls back,” says Jonathan Seif, Founder of The ProFolio Group, LLC in New York City, “they often get nervous and can even become too conservative, rather than taking a long-term outlook and maintaining an allocation that is appropriate.”

Yet, and we might have seen this over the last six months, investors are quickly able to shift from pessimism to optimism at the drop of the bull market bell. “Many investors have a short-term memory when it comes to the market,” says Seif. “When the market is firing on all cylinders, they forget about volatility in the past and increase their risk exposure in an effort to maximize their returns.”

Millennials might call this sometimes misplaced euphoria a “fear of missing out.” “During market highs there is this ‘FOMO phenomenon’ at work,” says Robert R. Johnson, Professor of Finance at Heider College of Business at Creighton University in Omaha, Nebraska. “There is something about seeing others get rich quickly that brings out the greed in all of us. And that’s more than a little dangerous to our financial health. We would be wise to heed Warren Buffett’s advice to ‘be greedy when others are fearful and fearful when others are greedy.’”

What’s a fiduciary to do in order to combat such topsy-turvy thinking?

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Before one can counsel, one must understand. It’s critical a fiduciary become fully aware of the motivations that can lead investors astray. In the past, the “rational man” of the Efficient Market Hypothesis might have prevented this understanding. Today, the answer is more readily accepted. “Investor psychology,” says Len Hayduchok, CEO of Dedicated Financial Services in Hamilton, New Jersey. “Ups bring about confidence euphoria and greed; downs bring about fear and panic.”

As the dominance of Modern Portfolio Theory has slowly faded, practitioners have followed the researchers in trying to better grasp the whys behind investor decision making that was in the best interest of investors. Johnson refers to the term “recency bias” as an explanation for this phenomenon.

“In October of 2017, University of Chicago Professor Richard Thaler received the Nobel Prize in economics for his work in behavioral finance,” says Johnson. “The premise of behavioral finance is that human beings aren’t rational profit maximizing machines, but often succumb to behavioral biases. One of the most common behavioral finance biases is recency bias, or the observation that we tend to overweight our most recent experiences and underweight experiences from the more distant past. In essence, many of the bitcoin speculators watch the market price of bitcoin rise and assume it is going to continue into the indefinite future.”

Markets are not rational and neither are those who invest in markets. William M. Francavilla of Barhamsville, Virginia, is a former director of wealth management at Legg Mason and author of The Madoffs Among Us, Combat the Scammers, Con Artists and Thieves Who Are Plotting to Steal Your Money. He says, “Emotions play such a huge role in investor’s decisions. ‘Fear’ when markets are low followed by ‘Greed’ when markets are high.”

A good fiduciary must keep a level head and know when emotions drive investors. After all, if they’re not careful, emotion will drive investors right off the cliff.

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary Solutions,  Hey! What’s My Number? How to Improve the Odds You Will Retire in ComfortFrom Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on TwitterFacebook, and LinkedIn.

 Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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