Advisors Can Make a Real Difference
While individual investors can take steps to manage their emotions, the evidence suggests that advisors can have a key role to play in combating the impact of loss aversion.
Research shows that investors who manage their own retirement accounts are much more likely to make changes to their portfolios in response to market moves than those who are in managed accounts. For example, the study of 401(k) participants cited earlier found that around 16% of participants in self-directed 401(k) plans made changes to their portfolios during the first quarter of 2020, with over 7% changing their portfolio allocations. In contrast, less than 2% of participants in delegated plans made changes and only around 1% changed their portfolio allocations.14
PEOPLE IN SELF-DIRECTED 401(K) PLANS WERE MORE THAN 3X AS LIKELY TO CHANGE THEIR PORTFOLIOS WHEN MARKETS FELL
This highlights the important role advisors can play in helping their clients avoid the pitfalls of loss aversion. Consider the chart below (see Figure 6). A hypothetical participant in a self-directed 401(k) was much more likely to have sold off equities during the painful first quarter. Since we know that sellers do not immediately reenter markets and seldom fully reverse their allocation changes, that hypothetical participant would have lost out on at least some of the sustained rally that followed the downturn.
In contrast, participants in managed accounts generally held on during the downturn and, therefore, fully enjoyed the benefits of the subsequent market rally.
In other words, those who benefited from the help of an advisor or investment manager were much less likely to make unsound, emotionally-driven decisions during the market downturn and, therefore, were likely to enjoy enhanced returns in the period that followed.
The bottom line is that advisors can do more than help their clients develop sound investment plans. They can also help those clients avoid making emotional decisions that undermine—or even destroy—those carefully laid plans.
A Presentation to Inform Clients
Behavioral finance insights can help guide clients, informing them of the adverse effects of impulsive and reactive financial decision-making. Now you can share the science behind the emotions with a client-facing presentation that is easy to present during a one-on-one meeting or in a group setting.
14 David Blanchett, Michael S. Finke, and Jonathan Reuter. Portfolio Delegation And 401(k) Plan Participant Responses To COVID-19. June 2020.
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