What does a Financial Advisor do?

The 24-Hour News Cycle

The 24-Hour news cycle has led to a glut of information from everything regarding public health to some of the most extreme politics. This had led to ‘everyone’ having an opinion on ‘everything.’ Opinions get recycled and hyped even more with each broadcast.

What in the past may have been a slow moving headline turns into either a crisis or proclamation of exuberance in the markets. When things appear bad, they drive down the stock market like an anchor. The same is true on the opposite side… when things are looking rosy the market takes off like a rocket.

Around the clock news and information lead to overstimulation. The desire to change things based on the current perceived crisis becomes ever present.

In reality, all this information is just noise. The noise existed prior to the internet and cable news but was just much less available to individual investors.

Algorithmic Trading and Market Speed

Making things even more dramatic are algorithmic traders. These are programs designed to hop on to momentum-based trades. When the market heads in any direction at all these traders amplify the move quicker than humans… but at the end of the day humans are the casualties or benefactors.

In this 2016 article that has aged very well entitled, ‘Can Slower Financial Traders Find a Haven in a World of High Speed Algorithms,’ you will read about how quick algorithmic trading was… but now it is even faster. In fact, the bear market and following recovery in March of 2020 was the fastest on record.

If you would have gone on a long vacation during that time in 2020 you may have completely missed any of the sensational panic in the market.

Having done nothing at all… made no decisions about how the crisis… you would have fared pretty well. For a year that included a Bear Market (2020), the S&P 500 ended the year up 18.4%. Long story short: Trying to act like a high frequency trader would have only hurt your returns.

Not doing anything at all was the right move. But that is much easier said than done. This is why you should hire a Financial Advisor. They are the voice of reason… the roadblock to prevent you from acting on your financial plan when you should be doing something… anything… else.

Buying High: FOMO

Expert traders, investors, and yes even your Financial Advisor should be telling you that it is impossible to time the market. There are just too many inputs to the system. The complexity of the market can’t be rationalized.

In fact, proponents of the Efficient Market Theory believe that the market is so complex that at best price action can be considered completely random. There is no signal, no indicator, and no theory that will aid in deciphering market direction other than it generally goes up over a long period of time.

FOMO, or the ‘Fear of Missing Out,’ is often the phrase assigned to those who buy equities at the very top of a Bull run. The price they pay for their share of the action is the most expensive. They are the last people to recognize the power of investing and enter at the worst possible time.

Since most experts admit that the market can’t be timed, the person buying at the top just may be them, you, or me!

But that’s okay as long as you have decided to invest based on a sound set of principles and your time horizon doesn’t require specific immediate price action (a.k.a. gambling) to be successful.

This would mean that you had a responsible financial plan prior to entering the market… short term (and increasingly speedy) market downturns are not something that should shake the foundation.

Selling Low: Loss Aversion

But what happens when you buy at the ‘top’ and now the value of your investments has tanked 20%… maybe even 30% in a few weeks? Will you have regret? The natural human response studied by psychologists is that you will feel a sense of ‘Loss Aversion.’

Loss Aversion is considered a cognitive bias. To put it simply: humans are more upset about losing $5 than we are about finding $5. Even though the amount is the same, we are hard wired to have a stronger emotion about possibly losing what we have rather than earning more.

Psychology Today has an excellent way of describing this concept differently in an article entitled, ‘What is Loss Aversion‘:

‘The principle of loss aversion also applies to the emotional pain of scaling back. While we indulge in buying things, such as a larger home or a new car, we think that we can always downsize if we can not afford those purchases. But in reality, downgrading to a smaller home is psychologically painful. Being wealthy doesn’t help. For rich people, the pain of losing their fortune exceeds the emotional gain of getting additional wealth, so the rich often become vulnerable and anxious.’

In essence, when the market tanks we become fearful that we will lose what we have left invested. We are strongly compelled by this bias to act. Thus, we end up selling at the bottom. Nature inspires us to fulfill the prophecy of buying at the top and selling at the bottom.

But we are not doomed!

Our Financial Advisors are paid to be aware of our Loss Aversion. They understand it. They will be aware of this while you are screaming over the phone to sell everything when the 24-hour news cycle repeats ad nauseum about how the world is ending.

How to Make Sure your Advisor Doesn’t Fail

So now we know the problem. The problem is us. Our Financial Advisors’ most important job is to help us step past our biases. Here is a list of things that you and your financial advisor should be doing to ensure that they will be successful at ensuring you are successful.

• Choose a Financial Advisor that Matches You – Your Financial Advisor is a person, and each person has their own style. Whoever you choose must have the ability to talk reason to you when you are hyper emotional. I wrote an article on how to choose a Financial Advisor here for more details.
  
  
• Talk to Your Financial Advisor about What to Do During a Downturn – Talking to your advisor when things aren’t falling apart in the market is key to ensuring that you know the plan prior to needing to use it.
  
  
• Commit to the Plan – Whatever you and your Financial Advisor hammer out in terms of a plan commit to it. If you want to establish timeframes to reevaluate your plan every couple of years during a particular season, then decide on that in advance. Don’t make changes based on perceived market conditions.

   

• Ensure Your Portfolio is Diversified – If you are invested in a few single companies then the volatility can be incredible. The number of companies that have significant drawdowns during any given year is astronomical.

That said, if you are diversified with a large basket of equities and bonds you will find the downturns are much rarer and more easily weathered. Make sure your portfolio is diversified… hopefully your Advisor will already have you headed down this path. If not, then fire them!.

Do Your Research

I write this blog as an expression of my opinion, and nothing written should constitute formal investment advice. Do your research. Learn about the various biases that may affect your behavior and establish a framework to help you see past them. At the end of the day your investment performance ends with you, but if you inform yourself with the right relevant information, you will likely find success.

Summary

The most important thing your Financial Advisor can do to earn their keep is talk sense into you when emotion overrides the rationale parts of your brain. Understanding that we will be defenseless at times and wield the power to destroy ourselves despite good intentions is why your Financial Advisor must step up to the plate.

I hope you enjoyed this article. If you have any other thoughts on the matter, or perhaps a time that your advisor (or anyone else) stepped in when you tried to sell at a market bottom, please put it down in the comments.