Financial advisors often promote their services by saying that they can help remove emotions from investing. In theory, advisors can use a variety of risk management tools, knowledge of capital markets, and long-term investing perspectives to help their clients avoid making costly knee jerk reactions.
Brexit is just one example, but it can be a powerful case study for advisors seeking to help clients understand why emotions should be curtailed by financial professionals who are armed with capital markets expertise.
In the months leading up to the Brexit referendum, markets climbed and declined in response to changing expectations for how the country’s citizens would vote. In the final days before the vote, investor sentiment strengthened as pundits increasingly said a vote in favor of the U.K. pulling out of the European Union was unlikely.
Many investors had previously feared that Brexit would hinder economic growth in Europe and create a challenging environment for U.S. companies and business in other countries that sell products in the continent.
Indeed, Brexit is likely to mean that U.K. will have to forge new trade agreements with individual members of the European Union and is likely to have to do the same with U.S. exporters.
When the Brexit referendum surprisingly determined that voters want to leave the U.K., panic ensured. On June 24, when the results were released, U.S. equities dropped approximately 3%. It was the worst single-day decline for the S&P 500 in nearly a year and wiped away the index’s gain for 2016, according CNBC.
By the end of June 27, the index had dropped 4.07%. The decline, however, was only temporary. Indeed, during the last three days of June, the S&P climbed 4.95% and, as of July 8, had generated a total return of 4.21% year-to-date.
Investors who panicked by selling in the days immediately after Brexit are likely to have sold during a dip, only to miss the strong returns when equities bounced back. With that in mind, advisors should explain to their clients that panic selling often results in selling low and then missing out on the strong returns that typically follow market dips.
They should explain, furthermore, that using portfolio diversification to cushion declines, maintaining a long-term perspective, and understanding the role of corporate fundamentals can go a long way in helping investors avoid panic selling.
Advisors should develop illustrations that show how having a mix of asset classes could have reduced the impact upon a portfolio of the post-Brexit market decline and that portfolio rebalancing may have resulted in buying equities during the market dip.
They should also show index performance numbers that illustrate how riding out historical market declines, including the correction associated with the Great Recession, would have allowed investors to recoup losses and then eventually achieve additional gains.
Finally, advisors should point out that corporate fundamentals don’t justify a major prolonged market correction. While overall corporate earnings in the U.S. have taken a hit due to cheap oil, many industries, such as Information Technology, are experiencing strong sales and improving profits.
Innovation, meanwhile, is allowing companies like Amazon.com and Netflix to rapidly grow their earnings by disrupting traditional business models with technology. At the same time, corporations are holding near record levels of cash, which is allowing them to buy back stock, launch dividends, and conduct mergers and acquisitions at near record levels.
All of those actions provide additional support to stock prices. The U.S. economy is also likely to support corporate fundamentals. While U.S. economic growth has been slow, many developments are encouraging, with the labor market strengthening, real estate values increasing, and consumers’ finances improving.