Share this content
A man working from home while trading stocks or crypto
iStock_svetikd_businessman working

How to Advise Clients Who Fear Market Volatility

by

Clients might lose faith in long-term investing when stock prices fall, but stocks remain a worthy investment when the right strategy is implemented. Here, Bryce Sanders explains why dollar cost averaging might be a good way to help clients face financial fears when it comes to the stock market.

May 9th 2022
Share this content

Sometimes history repeats itself. Years ago, when I was a financial advisor in Brooklyn, New York, a large number of people leaving Eastern Europe, where inflation was high, and settling in the United States. When it came to investing, some people assumed all stocks went up in price, and some went up faster than others. The most recent bull market for stocks lasted about 11 years. Suddenly, clients discovered that stocks can also go down, which led some to lose faith in long-term investing. How should you advise these clients? They may ask, “Why throw good money after bad?” Others might say, “If you find yourself in a hole, stop digging.”   

Stocks have historically been a good investment if you have a long-term view. Let us start by looking at the numbers. The Ibbotson Stocks, Bonds Bills and Inflation (SBBI) chart is a standard industry reference. Large capitalization stocks have averaged an annual return of 10.2 percent between 1926 and 2019. Government bonds average a 5.5-percent return and Treasury Bills follow at 3.3 percent. Meanwhile, inflation averaged 2.9 percent over that period. Small capitalization stocks averaged 11.9 percent during the same period. The stock market has done swell over time.

If clients invest in the stock market, volatility comes as part of the package. As Warren Buffet once said, “Only buy something you would be perfectly happy to hold if the market shut down for ten years.” His message is to think long term.

The Concept of Dollar Cost Averaging

Clients might think market time is the solution: Sell high and buy back at lower prices. Historically, this doesn’t work. DALBAR Inc. has tracked average stock market returns and the average returns of (stock) mutual fund investors, some of whom attempt to time the stock market.  DALBAR reported that over the 30-year period from 1/1/92 to 12/31/21, the S&P 500 index averaged an annual return of 10.65 percent, while the average mutual fund investor has a return of 7.13 percent.

Your client should consider dollar cost averaging as a strategy to get into the stock market and stay invested. A recent article by FINRA makes the point that clients are probably already using this strategy inside their 401(k).

The concept is simple: Instead of investing all at once, you invest a certain amount every month over a long period of time. A good analogy is going into the ocean while you are on vacation. If you ran into the sea, you might head straight into a wave and get knocked over. Maybe the tide would suddenly go out and you would lose your footing. If you walked into the water at a steady, gradual pace, however, you would find yourself riding the waves as you progressed.

Your client should understand the analogy, but numbers will help. Imagine your client received a $24,000 bonus in January. They intended to buy a stock mutual fund, exchange traded fund (ETF) or maybe an individual stock. Let us suppose this investment was $10 a share on January 1. If they put all their money to work at once, they run the risk of buying at a high point or a low point.

If they invested $2,000 a month at the start of each month, they would put the entire $24,000 to work over the course of the year. In the first month, their $2,000 bought them 200 shares at $10 a share. February 1 told a different story. The share price is $8.00. Their $2,000 now buys them 250 shares. This averages their cost down to $8.89 per share overall.

March 1 delivered a brighter picture. The share price is now $12.00. Their $2,000 buys them 166 shares. Overall, their $6,000 has bought them 616 shares at an average price of $9.74 per share. There is also the advantage the uninvested funds are also earning interest. Vanguard did a study in 2012 showing better results 66 percent of the time. This is meant to be a long-term strategy.

This strategy might seem boring, but there is a psychological reward to knowing your automatic investment is buying more shares when the market is lower, decreasing your average purchase price per share. From an accounting perspective, your client is not incurring capital gains and losses every time they jump into or out of the stock market. They are gradually building a position over time. If they invested in mutual funds, the major tax consequence during their holding period is the long and short term capital gains declared each year by the fund managers.    

If your client believes in the long-term potential of the stock market, yet volatility causes them to lose sleep at night, dollar cost averaging may be a good strategy for them.

Replies (0)

Please login or register to join the discussion.

There are currently no replies, be the first to post a reply.