Q&A: How to make smart decisions in a volatile stock market
When the stock market swings wildly, investors naturally ask themselves: What should I do?
It’s Michael Liersch’s job to help them answer that question. He’s the head of behavioral finance at brokerage giant Merrill Lynch, a unit of Bank of America Corp.
Liersch studies how and why investors react to market moves and shares what he’s learned with the 15,000 Merrill Lynch financial advisors who deal with the public. (Some other Wall Street firms have investor-behavior departments as well.)
Investors’ mettle has been tested lately. The Dow Jones industrial average briefly plunged 1,000 points in one session a few weeks ago, setting off days of chaotic swings, and experts predict more volatility before the year is out.
So we asked Liersch, 39, to discuss how investors react to such turbulence and the mistakes they often make. Here’s an excerpt:
There’s an old saying that each day the stock market is a battle between investors’ fear and greed. Is it your job to sort that out?
It’s really helping investors take a step back from judging themselves that way. When you think of the words “fear” and “greed” there’s an automatic judgment that you’re on one side or the other.
Meaning they’re not always afraid or greedy?
What I like investors to focus on is what matters most to them [with their money]. Is it their family? Maybe they have kids they want to support, or are saving for retirement. Is it a special-needs family member they want to make sure is going to be OK?
It’s within the context of those goals that they would ask, “Should I be behaving differently based on the market’s movements?”
Sounds fine in theory, but when markets are plummeting there’s an urge to do something, right?
The major mistakes people make is thinking they either need to take extreme action or to completely ignore the markets when there’s a lot of volatility. The fact is, there’s no one correct way to behave during times of volatility.
You should always be engaged in how your money is working. The question is: Should something change about my investments based on what’s happened in the markets in the context of what I’m trying to accomplish?
So context is king?
Let’s say the goal is to buy a house in a month, and for whatever reason the investor is all in equities. Are we concerned [the portfolio] is not going to make the down payment to buy the house? Then that’s where you step back and maybe make a change.
But if you’re 35 and your financial-retirement goal is 30 years out, we’d have a different approach.
When the markets were going crazy a few weeks ago, what were your clients saying?
Why is this happening — and should I do something about it? Should I make a change?
Were you and Merrill Lynch’s advisors telling them to calm down?
When you’re feeling a certain way, how does it make you feel to be told to calm down? A better question is: “Why are you feeling this way?”
Let’s take a look at your goals and let’s refocus on what matters to you and your personal situation. If an investor is extremely nervous then perhaps they need more cash on the side [and fewer stocks].
Is it true that individual investors are lousy at timing the markets when stocks are so volatile?
Yes. Time and again data show that investors tend to enter at market peaks and exit at the valleys. Some research suggests this behavior costs investors multiple percentage points annually in investment returns.
How does one avoid this mistake?
Work with someone who can provide checks and balance for your choices. That might be a spouse, a partner, a trusted professional. That person can help you make the right trade-offs.
Another way: Dollar-cost averaging. Invest a set amount of money toward your goals [each month] regardless of market movements. When markets are going down, you continue to buy investments “on sale” and when markets are going up, you are not waiting too long to put your money to work.
Ultimately it comes down to how much risk a person is willing to take?
I tell people, here’s a coin flip: Heads you get nothing, tails you get $100. Or you can opt out of the coin flip and I’ll just give you $20. What would you do?
Maybe you need the $20. But other people like to gamble. There’s no way, except in hindsight, to create a right answer.
The best answer is based on what you’re trying to accomplish with your money. It’s a goals-based conversation. That’s a much different conversation than simply saying, “What should I do?”
Twitter: @PeltzLATimes
