Taking action or locking in the losses?

During times of market volatility, when investors feel that they are haemorrhaging money, a natural instinct is to stop the bleeding—to take decisive action instead of riding out the storm.

Though taking action in the face of difficult times often works out well in everyday life, when it comes to investing, acting on that desire won’t necessarily help. To help ourselves and investors overcome this tendency, let’s better understand what’s happening.

A bias for action

Action bias is our tendency to take action for reasons that are generally valid, but not in the specific situation, especially when we focus on the benefits of action and ignore the costs. In our minds, even if acting and not acting result in the same outcome, that outcome feels so much worse when we didn’t take action.

The ongoing market volatility we’re experiencing will create a vicious cycle, where suffering losses because we didn’t make a change will be more emotionally taxing than experiencing losses after we made a change. In our minds, at least we tried to do something. Following are a few reasons many investors might be experiencing action bias right now.

• Experience can’t always save us. A tendency toward action bias is something we appear to all suffer from, even those who are experts in their field. Even though investors may know they should stick to their financial plan, they may still feel pressured to act.
• Seeing an impact now is more salient. When we take action in our current situation, we can immediately see the impact. If we ride out the storm, we won’t likely reap the benefits of this decision for months to come, which can make it even harder to resist action bias.
• Investors are struggling under the weight of responsibility. Many of us may feel personally responsible to take action to protect our savings for the sake of our loved ones. Research finds that people who are in a role—either familial or professional—that makes them responsible for an outcome are more prone to exhibit action bias.

How to combat action bias

Our biases, including action bias, aren’t something we can erase, but we can accommodate them in our lives. Instead of watching clients fall prey to action bias, advisers can help them redirect that urge for action.

• Help investors refocus on their goals. This may be a great time to help investors refocus on their goals. Morningstar created an exercise to help investors systematically understand their preferences when it comes to their financial goals. The three-step process may help investors slow down, take a step back from their emotions, and home in on what really matters.
• After helping investors redefine their investing goals, it may help to demonstrate that their current financial plan is still on track to meet these goals. It’s natural for investors to see volatility as a reason to panic. Advisers can act as the voice of reason throughout this upheaval by explaining to clients that even though their portfolios have seen better days, given their asset allocation and time horizon, they are still on track.
• Take action where it counts. There are a few things investors can do during market volatility to take control of their finances. Christine Benz and Susan Dziubinski talk about a few tips in a recent video, including things like increasing your saving rate to take advantage of market weaknesses, keeping an eye out for tax-saving opportunities, and capitalising on lower interest rates.

Periods of market volatility are a scary time for any investor, but there is no reason our fear and anxiety should get in the way of our financial plans. Using simple techniques like these can help us all make more logical decisions and stay on track.