There is an analogy psychologists use to think about how our brains work. It is called “the elephant and the rider.” It sounds crazy I know, but bear with me. Your brain has higher functions and is capable of making rational decisions (the rider), but it also has powerful emotions that can lead it to react strongly to anything that causes fear or tempts with things it likes (the elephant).
We use this analogy to think about how people react to market corrections. Big moves down cause fear and the elephant wants to run. The emotional part of your brain wants to protect what you have and run away from stocks. Interestingly, elephants move in herds. The tendency for investors to sell when everyone else is selling or buy when everyone is buying is called herding behavior.
The rider knows that rationally, corrections happen and that over time markets will recover and continue higher. The rider knows that the smart thing to do is to stay on the path. However, the rider is generally small and it is not always easy for him or her to control the elephant.
I talked with Cindy who is a really talented young planner in our office and coincidentally the only person I know off the top of my head who has actually ridden an elephant. Cindy went on a trip to Thailand last year and according to her, “rode the biggest elephant there.” I asked how she controlled the elephant. She said that she didn’t because every elephant had a handler. The handler was the elephant’s best friend. He introduced her to the elephant then walked calmly along with the elephant so that it would stay on the path and not throw her off. So the handler kept the elephant in check so that she could enjoy the ride and get to her destination.
You probably figured out where I am going with all of this. As financial advisors we often act as the handler for our client’s elephants. We help keep the elephant on the path when emotions try to take over. When markets are good and our clients want to own more stocks, we usually advise caution. When volatility is high and our clients want to sell, we remain calm and try to keep them on the path to success.
We have experienced a few volatile days in the market. Big moves down get headlines and in some cases selling leads to selling even when there isn’t a big global event. Herding behavior is very real and some investors will be quick to sell at the first sign of trouble. If things get worse, the size of the herd will increase. Usually the best advice we can give is to stay calm and stay on the path.
Bottom Line: Remember that volatility is a normal part of investing. It is the price we pay for the better long-term returns that stocks offer. That said, we know that volatility can be stressful. Give us a call if your elephant needs to talk.
From the desk of Kris Carroll, CFA®, CFP®Market Update, Market Volatility