Three (3) Psychological Traps to Avoid During Market Uncertainty | Mission Wealth

[Music] When markets turn negative, our emotions often do, too. Fear and stress and uncertainty can push even seasoned investors into becoming market timmers, making irrational, knee-jerk reactions, especially with this week’s attention grabbing headlines. At Mission Wealth, we help our clients stay calm and focused during turbulent markets by avoiding some of the most dangerous psychological traps and by crafting resilient diversified portfolios. Here are the top three psychological mistakes to avoid during this down market and what to do instead. First, let’s cover some of the worst investment behaviors that can build up and lead to making bad decisions. Hold yourself accountable.

Ask yourself if you’re doing any of the following. Are you checking your investment performance too frequently, such as daily or weekly? And when you check your accounts, do you focus on the dollar amount, not the percentage, that has changed in the day, month, or quarter? Do you often read headlines or articles about the total market, even if you are diversified and hold a fraction of your portfolio in that market? And lastly, are you considering selling or moving to cash to stop the losses? If you answered yes to any of these questions, then the three topics below will be your best defense in how you digest financial information during a declining market. The first trap is salience bias and the news cycle.

Salience bias is our tendency to focus on the most emotionally striking information, often what’s loudest in the news. News headlines are engineered to get clicks and eyeballs, not to make you a better investor. So headlines like stocks plunge or the Dow has had its worst day since a certain year or billions have been wiped out from markets. These are all designed to make you feel something and your fight orflight senses tell you to take action. With history as a guide, we can actually see that the time period after some of the worst headlines tends to offer positive results in the marketplace. See a few examples from Time and Newsweek magazine covers during prior pullbacks with the Dow’s subsequent performance below each magazine cover.

We can see this with even more clarity with almost 100 years of data. The average 1-year return after a 10% market decline was positive 11.7%. Instead, keep these critical points in mind to preserve your sanity when investing through a market pullback. Don’t judge your portfolio by the S&P 500 or Dow alone. Most of our clients and most investors have more diversified portfolios than just one market. You likely already own some international stocks or real estate or cash. If you only have US stocks, chat with your adviser about the benefit of diversifying into new markets and adding other areas to your portfolio. If you have a concentrated position, chat with your adviser about put options and how that might limit downside risk. You should understand the total exposure your portfolio has to the marketplace, not just an isolation. So, for example, if a diversified portfolio has a negative 3% return versus the S&P losing negative 14%. It’s dodged about 80% of the market correction. And if you’re near an emotional break point and want to move to cash, talk with your adviser about moving things in the

portfolio that may not be as extreme as putting everything in cash. This is some of the best time to buy bonds or you can buy private credit, real estate, or infrastructure, other areas that might produce predictable income in the form of dividends and interests. and you can let the stock portion of your portfolio recover since you may not be tapping into it for living expenses. Chat with your adviser if you can get enough predictable income from investments outside the stock market to meet your basic lifestyle needs. The second trap to avoid is anchoring bias. Anchoring is when we latch on to an arbitrary number like your portfolio’s highest value ever or the January 1st value and we use that as a baseline for all future judgments.

Looking at short-term data will cause you to make short-term decisions. Beware of the worst since headlines, which are a classic example of anchoring. They subtly trick your brain into comparing today’s market to recent points in history. And here’s the problem with that. Markets are going to fluctuate. That’s not a bug, it’s a feature. By comparing everything to a recent high, it’s not helping you make an informed long-term decision. Take the chart below as an example, which shows some of the worst headlines that we’ve seen in the last 50 years. As you digest that, I want to share some of the worst anchors we see investors can have. First, recent highs or lows. Investors may feel compelled to buy at highs or sell at lows based on short-term price movements, and they often compare their portfolio to those arbitrary starting points like January 1st or the prior month’s end, the prior quarter’s end.

Second, purchase price. A lot of investors hold on to positions which have lost value in hopes of recovering it. Often convincing themselves that they will sell it back when it reaches what they paid for it. Not only does this miss a taxless harvesting opportunity, but the purchase price may also not reflect factors like earned income. Three, market index performance. Investors often compare their investment performance solely against one market index, even if they have invested across different types of markets. Fourth, volatility. Investors don’t have an anchor in mind for what normal volatility is. The S&P has a normal range of movement between positive 43 to -23. If you invest in the market, you need to know what a normal range of movement is for your portfolio, which is going to be par for the course of what you’re signing up for. You can read more about that in our Q3 2024 commentary. Some better anchors for investors would be long-term returns.

How are you doing over a 3 plus year time period? Do you compare your portfolio performance to a weighted benchmark which accounts for all the markets you’re invested in? On the income side, is your portfolio producing enough income that you need regardless of market growth? And lastly, on the volatility side, do you know what a normal range of movement for your portfolio is? In your financial plan, you can anchor to some safe limits. How much risk in dollars can you afford to take? What’s your maximum spending capacity? and what’s your minimum rate of return needed to be financially secure. Talk with your adviser about these safe limits of your financial plan. The last trap we’re going to go over is action bias. Simply put, we feel the need to act and we can get in our own way with emotionally charged changes to our investments. We are hardwired to take action and to do something. It’s our fight orflight response. On the other hand, if we do nothing, the patience can be perceived as in action which will nod us.

Realize that there is no shortage of reasons to be concerned. While the S&P 500 produces a positive result about 70% of the time, the average decline within each year between January and December averages a negative 14% decline each year. That’s data since 1980. Draw downs are normal. Even if their causes are unpredictable, there’s always going to be something going on. So, how can an adviser help? At Mission Law, we have an arsenal of research at our fingertips to help you navigate market pullbacks. To name a few, we have third party stress testing software that can model how your portfolio may behave under different economic scenarios. Modeling draw downs caused by tariffs or a tech AI bubble, elevated inflation, or an S&P correction. We can compare your portfolio to our recommended changes under these scenarios and quantify potential risk reduction. for concentrated positions in specific large companies. Discuss how put options might be used to provide downside protection.

We have a dedicated options trader inhouse on our investments team. For some potential investment tweaks, consider the following. For income producing investments, talk with your adviser about how bonds and private credit might fit into your portfolio. For hedging potential tariff induced inflation, talk with your adviser about how real estate and infrastructure investments may fit into the portfolio. And lastly, for growth outside of US public stock markets, chat with your adviser about how private equity, venture capital, and international equity may fit into your overall allocation. For recent retirees, we can model a bad timing scenario in your financial plan to show how a market downturn in early retirement may affect your plan success. Chat with your adviser about this option. And lastly, if you’re very concerned about long-term growth, we can always discuss using a lower return assumption in your financial plan to be extra conservative.

We can tell you what a safe minimum return you need is to have a successful financial plan for the rest of your life. So in conclusion, the reality is that markets are going to zig and zag for a whole bunch of known and unknown reasons. Plan for and planning for unexpected expenses is the name of the game. Building an effective defense against world headlines is not about predicting what will cause volatility. It’s about expecting volatility to arrive and building a resilient portfolio to mitigate the volatility when it comes. We have a separate article that would be linked in this publication for how we manage market volatility. And we’re always happy to chat about any concerns or questions you have. If I may end on an analogy, it would be this. A skilled sailor does not need to know what causes every wave in the ocean to know how to safely sail across the seas. We hope you found these topics helpful as we enter the second quarter of the year. For more detailed market commentary and to stay uptodate on the economy and tariffs, I welcome you to read or watch our chief investment officer’s market updates from our

inserts blog. To submit any requests for future topics, please don’t hesitate to email me directly at jkhur ymissionwealth.com. Thanks. [Music]