When I think about the next downturn, I think about rats.
We recently had a leading neuroendocrinologist, author and expert on stress, Dr. Robert Sapolsky, speak at our national conference. He detailed a classic 1970 study that found when rats were given a warning before getting a small electrical shock, they experienced significantly diminished stress levels compared to rats that received no warning. The latter group apparently lived in an unpredictable world of stress.
Sapolsky noted that having another rat in the cage also helped minimize stress.
While I don’t want to compare financial advisors and their clients to rats, this research has important implications for how we prepare clients for the next down market.
I’ll admit, I have no insights or prediction on when the next serious market downturn will occur, only that it is coming. Like death and taxes, down markets are unavoidable for market investors. The only question is when—next week, next month or several years from now? The fact is, I know it is coming and I am perfectly fine with it happening.
Over the last 113 years, from 1900 to 2013, we’ve seen 32 bear markets (defined as a market decline of 20 percent or more from peak to trough). That averages out to one bear market every three and a half years.
Periodic market declines are the necessary and normal price of successful investing. It is unrealistic to expect to earn the long-term historical returns of global markets and the companies they represent without experiencing some ups and downs along the way. To state the obvious, if there were no risk, there’d likely be no return.
But, there is something that can transform declines from an annoying blip into a permanent loss: human behavior.
I’ve been asked numerous times over the past six months about what keeps me up at night as CEO of Loring Ward. My answer is consistent: the threat of clients changing their long-term plans when the next downturn happens. I am convinced that the best portfolio in the world can quickly be ruined by bad investor behavior. When short-term emotions get in the way, they can potentially compromise, even derail, long-term financial plans.
Knowing all this, and not forgetting the rats, my challenge to all financial advisors is this: What are you doing—while markets are still performing well—to prepare your clients (and yourself)?