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Steering Participants Through Market Mania

Steering Participants Through Market Mania

January 29, 2024

Conversations on market volatility often conjure up nail-biting narratives about panicked sell-offs, as jittery investors rush to liquidate positions to avoid incurring further losses. However, it’s important to acknowledge that market volatility has two faces. And while upturns are certainly more welcome than their counterparts, they carry their own psychological challenges for investors. The intoxicating rush of a tech surge or a post-crisis rally can be as disorienting as a market seemingly in freefall. As stocks soar and portfolios swell, investors may find themselves grappling with a different set of emotions, but the end result can be equally detrimental to long-term financial health when certain biases set in.

Overconfidence. Investors riding the wave of a bull market can develop a skewed perception of their own investment acumen. It can lead to ignoring diversification, failing to assess new information objectively and taking on excessive risk, presuming that past success guarantees future results.

Herd mentality. This collective behavior can amplify market movements, both upward and downward, as prudent analysis gives way to mob psychology. The tech bubble of the late 1990s and the housing market crash of 2008 serve as stark reminders of how herd mentality and “irrational exuberance” can distort market valuations and inflate bubbles until they eventually burst.

Recency bias. Weighing recent events more heavily than historical ones can distort an investor's perception of the market, causing them to expect the continuation of current conditions. After a prolonged market rally, investors might neglect the potential for a downturn, overlooking the cyclical nature of markets.

Underestimating market risk. It’s easy to view investments through rose-colored glasses during periods of growth, but volatility can return with little warning. Adequate risk assessment includes preparing for the possibility of market corrections and ensuring that investment decisions align with one's risk tolerance and long-term objectives.

Fear of missing out (FOMO). This insidious fear can push investors to make impulsive decisions, such as entering a soaring market at its peak out of fear of missing further gains, only to be caught in the inevitable downturn.

All of these biases cloud judgment, potentially leading to risky investment behaviors that undermine long-term financial goals. But plan sponsors can help mitigate some of the downstream negative impacts of raucous rallies. Potentially helpful strategies include offering education around the ebb and flow of historical market cycles, encouraging regular one-on-one financial advising and including instruments in the investment lineup that take a lot of emotion out of the portfolio management equation — such as target date funds. Implementing automatic rebalancing can help keep investments aligned with target allocations based on an individual’s risk profile. Email alerts to employees during periods of high volatility (both up and down) can help educate participants about the nature of market fluctuations and underscore the importance of adhering to a prudent, long-term investment strategy.

Plan sponsors have the opportunity to help cultivate a holistic understanding of finance and the markets, providing a framework for participants to make informed choices and navigate the complexities of investing with greater confidence and clarity. A proactive approach can help foster a culture of financial wellness that transcends market cycles.