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Posted by on Oct 6, 2016 in ETF Strategist, Investment Perspective

Can You Rationally Process Market Events?

Can You Rationally Process Market Events?

By Roger Nusbaum, AdvisorShares ETF Strategist

A friend passed along an interview with Daniel Goleman from the CFA Institute that focuses on how to be a better advisor but I would argue can help individual investors as well. I believe there is a lot of overlap here to what I have been saying here for many years so it is neat to read about other people drawing similar conclusions.

He breaks it down into four components; mindfulness, emotional intelligence, empathy and relationship skills (those last two probably are more geared to advisors more narrowly).

This post will focus on mindfulness which is about emotional, mental and physical wellbeing coming before anything else. Everyone has their stuff, their hot buttons or vulnerabilities. I think the way I have approached this concept is to focus on figuring yourself out, understanding what is important to you which then lets you understand what isn’t important. Years spent chasing the wrong things is time wasted.

For advisors I would say that whatever thing most concerns you is very likely far down on the list, if it is even on the list, for most clients. Most clients rightly want and need to know their advisor has them on track to where they need to be in pursuit of whatever their financial goal might be. Save for a few engineer-types they are not myopically focused on the performance of one stock or one fund.

The additional layer of importance here is that not every decision can turn out to be correct and everyone around the table needs to understand this. The implementation of a portfolio and execution of a financial plan are simply a series of decisions and hopefully the combo of correct and incorrect decisions yields the desired result or at least gets reasonably close to the desired result.

For individual investors, having your emotional and fitness houses in order will better let you keep your investment house in order. If you have proper diversification and reasonable position sizing, then you know that a single stock or narrow-based ETF cannot derail your financial plan. If you only use broad based funds, then you know that an index won’t go down to zero. If you get blindsided by a very large decline you simply need to have patience (assumes proper asset allocation). It took the S&P 500 five and a half years to recover from the financial crisis and investors in the accumulation phase who kept adding to accounts throughout were much further ahead by the time the index recovered.

This likely leads to hindsight bias well of course the market recovered but in real time many people thought it was the end of the financial world. Whenever the next crisis comes, people will again think it is different and make poor decisions because of it.

As the article implies, this concept is magnified during large declines as an advisor must be the voice of calm. Declines are inevitable, a normal part of the stock market cycle. The circumstances will be different but the market manifestation is always the same; a large decline that scares a lot of people, a bottoming after some amount of time and then a recovery (Japan as the exception to prove the rule). Saying it now and remembering it then are two different things but that is point.

Goleman ties physical wellbeing to helping avoid or reduce stress. The connection is obvious but is always worth addressing. Stressors can build up to have a compounding effect and if they feel like they are maxing out on a day like Brexit Thursday or in the middle of some other fast decline they can trigger an emotional response that cannot be overcome.

Asking yourself should I sell is fine but actually doing it may be the wrong thing and too much stress impairs the ability to rationally discern between the two.