Sound the Alarm on Investor Behavior
Recently, I read a study published by the University of Oklahoma that found aggregate net equity fund flows are negatively correlated with changes in expected future stock market volatility, as measured by the VIX.1 I must admit, while it pains this University of Texas alumni to cite a study from north of the Red River, the conclusions from this study—and how we as financial advisors can apply these insights for the benefits of our investors—are highly relevant.
The study suggests that purchasing decisions made by investors are primarily driven by returns, and selling decisions are impacted by risk perceptions. This study concludes that there is no evidence that macroeconomic variables and consumer sentiment have an independent impact on mutual fund flows when controlling for the VIX and stock market returns.
This confirms what we suspect: that buying and selling decisions are motivated differently, and ultimately, can be counterproductive.
Essentially, when we buy something, we hinge on the positive factors that reaffirm our choices, and when we sell, we lean on negative data that reinforces the decision. When the broad view of volatility is low, as measured by the VIX, people are generally buyers. Conversely, when the broad view of volatility is high, as measured by the VIX, in general people are sellers. If this pattern dictates our tendency to buy from low volatility to high volatility—high prices to low prices—we know we have a problem.
So, how can we challenge this behavior? One approach is to use the VIX as a barometer as to when and how we engage clients. First, for our numbers-oriented clients who are glued to daily market fluctuations, we can advise them to set up an alert on their smart phone or mobile device to call us when the VIX hits or exceeds 25. On the other hand, for our more emotionally driven clients who love chasing hot performers, we can simply have them initiate the same alarm to call us and discuss if its the right time to rebalance their portfolio or harvest present gains.
The technique of using a real data points to assist in client conversations can help us remain “people focused” on something our clients can control, instead of being subject to the endless vitriol they hear or read in the financial press.