When the stock market swings wildly, investors naturally ask themselves: What should I do?
It’s Michael Liersch’s job to help them answer that question. He’s the head of behavioral finance at brokerage giant Merrill Lynch, a unit of Bank of America.
So the Los Angeles Times asked Liersch, 39, to discuss how investors react to such turbulence and the mistakes they often make. Here’s an excerpt:
Q: When markets are plummeting there’s an urge to do something, right?
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A: The major mistakes people make is thinking they either need to take extreme action or to completely ignore the markets when there’s a lot of volatility. The fact is, there’s no one correct way to behave during times of volatility.
You should always be engaged in how your money is working. The question is: Should something change about my investments based on what’s happened in the markets in the context of what I’m trying to accomplish?
Q: So context is king?
A: Let’s say the goal is to buy a house in a month, and for whatever reason the investor is all in equities. Are we concerned (the portfolio) is not going to make the down payment to buy the house? Then that’s where you step back and maybe make a change.
But if you’re 35 and your financial-retirement goal is 30 years out, we’d have a different approach.
Q: When the markets were going crazy a few weeks ago, what were your clients saying?
A: Why is this happening – and should I do something about it? Should I make a change?
Q: Were you and Merrill Lynch’s advisors telling them to calm down?
A: When you’re feeling a certain way, how does it make you feel to be told to calm down? A better question is: “Why are you feeling this way?”
Let’s take a look at your goals and let’s refocus on what matters to you and your personal situation. If an investor is extremely nervous then perhaps they need more cash on the side (and fewer stocks).
Q: Is it true that individual investors are lousy at timing the markets when stocks are so volatile?
A: Yes. Time and again data show that investors tend to enter at market peaks and exit at the valleys. Some research suggests this behavior costs investors multiple percentage points annually in investment returns.
Q: How does one avoid this mistake?
A: Dollar-cost averaging. Invest a set amount of money toward your goals (each month) regardless of market movements. When markets are going down, you continue to buy investments “on sale” and when markets are going up, you are not waiting too long to put your money to work.