If we have learned anything from facing the challenges of the past 21 months, it’s that the world of investing – and specifically, trading – is more open and accessible to everyday people than ever before.
The GameStop saga earlier this year provided an eye-opening realisation of just how easy it is for the average investor to trade stocks on their own – and just how prone they are to following trends.
Indeed, a surge of small investors using the Robinhood trading app triggered a massive short squeeze that drove GameStop stock 400% higher at one point before it began to fall. Many of those investors – who shared information through an online trading forum – first gained, then lost, millions of dollars.
We saw a similar behaviour in the Australian market, where Australian Securities and Investments Commission (ASIC) reported 280,000 new and re-activated share traders dived into the market at the peak of market volatility, where daily traded volume by retail traders doubled to $3.3 billion per day . With an average holding period of less than one day, ASIC estimated retail share traders lost over $230 million from trying to ‘play the market’ in this time.
Investors who steer clear of trading apps and instead listen to an adviser’s trusted counsel, have a much better chance of avoiding the pitfalls that investors working on their own frequently fall into.
Most advisers spend the bulk of their time trying to minimise their clients’ behavioural mistakes, especially when markets become volatile. This makes sense, particularly considering the findings of the most recent Russell Investments ‘Value of an Advisor’ report, which shows that taking on the role of behavioural coach may be the most important role a financial adviser can play. According to the report, preventing behavioural mistakes is responsible for approximately 2% of the 5.2% p.a. of additional value advisers provided to their clients’ portfolios in 2021.
Most advisers know far too well that investors don’t always do what they should. Instead, their behaviour is sometimes directly opposed to what is in their own best interests.
We don’t need a speculative frenzy such as the GameStop saga to understand how badly the average human wants to get in on a good thing, and how easily we are spooked by falling prices. We saw it in early 2020, when the COVID-19 pandemic first hit, and the markets shuddered. There were reports of significant movements from growth to defensive and cash holdings. Equities recovered steadily throughout the remainder of the year, and the S&P/ASX 300 had recovered losses by May 2021 and continued to hit record high levels in June 2021.
Left to their own devices, many investors buy high, usually at the top of a market cycle and sell low, typically at the bottom of a market cycle. The investor who bailed on the markets in March may have had a hard time finding a new entry point as the markets rose. They may have had to buy back in after the market had already recovered much ground. As Chart 1 shows, even being out of the market for a few days can have an impact.
Helping your clients avoid pulling out of markets at the wrong time and sticking to their long-term plan is one of the most critical ways that advisers provide substantial value.
The cycle of investor emotions
People have real anxiety when it comes to money. It is not so much the actual physical bill that causes the anxiety, it is about what happens when things go wrong. Sometimes that anxiety causes people either to make a bad decision or no decision at all. We often find the biggest detriment to an investment’s return is not the actual investment, it is the investor’s behaviour with that investment, especially when volatile markets make them anxious. An adviser who can keep their clients from succumbing to their human instincts to buy high and sell low can be incredibly valuable.
What does this all mean? Clients pay your fee because they are looking for someone to help them reach their goals. One of the key ways they can reach their goals is to stick with their plan during turbulent times. You can be the person who has the courage to fight your clients’ greatest nemesis – themselves.
Although it may mean having a challenging conversation, an adviser cuts through the noise and protects the client from making behavioural mistakes they are classically susceptible to – like buying GameStop on the way up and selling it on the way down, or selling all their stocks to buy bitcoin, or getting into tech stocks in the late ‘90s.
Obviously, this investor behaviour can hurt investor returns. Practically speaking, if an investor’s personal situation really hasn’t changed, then staying the course and riding through these periods of volatility is the logical course. But for humans, this is difficult. So, what can a good adviser do, since you can’t control the markets?
You can control – or at least help control – this very behaviour. That means instead of opening a trading account and getting financial advice from Reddit, an investor will have a conversation with his or her adviser who can coach their clients through these challenging conversations. That conversation – just that simple conversation – could save them from making a costly mistake.
Conclusion
Russell’s report highlights how individuals can fall prey to making behavioural mistakes, particularly following the upheaval seen last year. The good news is that you, as the adviser, can have a huge impact on investor behaviour and thereby on investment outcomes. In fact, addressing the investment behaviour of your clients may be the greatest value you can provide.
Bronwyn Yates is Russell Investments director, client and business solutions.
