How to Talk to Clients About Market Volatility

/ Don Connelly / Investing Wisdom / 2 comments

You don’t hear people talk much about market volatility until stock prices suddenly sell off. But when your clients watch their portfolio value decline unexpectedly, it can be terrifying, leading many to make potentially costly mistakes, such as selling into a steep market decline. Though we’ve experienced many volatile markets over the last 20 years, advisors must help clients understand that volatility is not their enemy.

As legendary investor Benjamin Graham once said, “The investor’s chief problem—and even his worst enemy—is likely to be himself.”

Market volatility can occur at any time, and, unquestionably, it can be frightening. However, helping your clients understand what volatility is, why it occurs, and how it actually helps investment performance over the long term can help alleviate their fears and learn how to embrace it.

This is a conversation every advisor must have with their clients at the beginning of their relationship, with timely reinforcement as volatility increases.

Help your clients put market volatility in perspective

It would help if your clients understood how stock market cycles work. Since its inception, the stock market has followed the same market cycle, consisting of bull and bear market phases. Volatility can occur at any time during either phase.

Bear Markets

Bear markets—marked by a market decline of 20% or more, can occur for various reasons, such as a weakening economy, a stock market bubble, a geopolitical crisis, or a global pandemic. On average, bear markets tend to last about ten months, resulting in an average stock market decline of 36%.

Bull Markets

A bull market is an extended period of rising stock prices. On average, bull markets have lasted about 2.7 years, with an average gain of 112%. Over the last 91 years, the stock market has been in a bull market 78% of the time.

So, we know that for every bear market, a bull market of longer duration follows with gains that have extended the gains of the previous bull market. Therefore, the real risk to investors is not the next 36% bear market decline; it’s missing a 114% gain in the next bull market. The key takeaway is that any market decline, no matter how severe, is nothing more than a temporary disruption in a longer-term upward trend.

Your clients biggest threat with volatility is how they react to it

When stocks turn volatile, the greatest risk to your client is not declining stock prices. It’s how they react to it. There is a natural urge to flee the market when prices tumble, but you must remind your clients that the only way they can lose money is to sell into a market decline. History has proven that investors who can weather stock market volatility and avoid costly behavioral mistakes are eventually rewarded with higher prices.

It’s also important to remind your clients that market volatility goes both ways, with as much volatility on the upside as on the downside. But investors tend to be fixated on the latter, which can hurt their investment performance. Decades of data show that investors who flee the market to avoid the biggest declines often miss out on the biggest gains, making it almost impossible to overcome the losses they incurred.

Here are some other tips to incorporate into client conversations about market volatility:

#1. Ignore the media noise

The media needs to sell advertising, and bad news sells better than good news. The information investors get is usually centered on driving viewership rather than conveying optimal investment decisions.

Your clients need to know that while this month’s investment returns or calamitous economic events may be consequential to our lives right now, their impact on our portfolio over a 20- or 30-year time frame is so minimal as to cause nothing more than a tiny blip on their long-term performance.

#2. It isn’t a loss if you don’t sell

During severe market downturns, many investors are prone to act, to do something to avoid losing money. It’s vital to convey to your clients that they can only lose money if they sell into a market decline. If they do, a “paper loss” becomes a permanent loss of capital, which is difficult to recover. The risk of loss is always self-induced for investors who flee the market.

#3. Learn patience and discipline

Extreme market volatility can cause investors to make costly behavioral mistakes, such as trying to time the market, which invariably leads to poor portfolio performance. Investors who stick to their long-term investment strategy tend to outperform those who don’t. Since the beginning, the stock market has always rewarded patience and discipline.

#4. Stay focused on your financial plan

No one can predict the next big move in the market. So, worrying about short-term fluctuations that won’t impact your long-term goals is unproductive. Warren Buffett says he only focuses on things that are knowable and important. For your clients, the only thing knowable and important is their long-term goals and the investment strategy you’re using to help them achieve them.

Clients with a historical perspective of the market and conviction in their financial plan are more inclined to stay the course while enduring brief periods of market volatility.

Watch this 3-minute video to learn how our Volatility & Bear Market Tool Kit can help you calm client fears and open new accounts during turbulent times.

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