PIMCO Education

Behavioral Science in Uncertain Times

During periods of extreme market volatility, investors often focus on short-term returns not long-term goals. Learn how advisors can help reduce negative consequences of emotional decision making by providing valuable guidance in this video.

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Text on screen: PIMCO Educational Presentation: "Behavioral Guidance During Market Volatility" with host John Nersesian (15 minutes)

Hi, I’m John Nersesian, Head of Advisor Education at PIMCO. Thanks for spending some time with us to review some really important concepts around behavioral guidance during market volatility.

I recognize that as financial advisors, you have many different challenges before you, providing investment guidance, doing advanced financial planning, helping your clients set realistic goals and managing expectations. There’s another important role, though, within the function of a financial advisor, and that is providing the kind of guidance needed to manage emotions and to help our clients make better decisions in an attempt to achieve better outcomes.

For those of you who are less familiar with the concept of behavioral finance, its roots go back many years. Conventional finance, the subject that we studied many years ago at university, suggests that individuals evaluate their options and they optimize their decisions to achieve the best outcomes.

But in the real world, decisions are often not made that way. Investors don’t often process information correctly. They infer incorrect probabilities and make mistakes regarding the assumptions of future rates of return. These behavioral biases often have a significant impact on both the decisions we make and the outcomes that we eventually achieve. Let’s take a closer look at the cost of these bad behaviors.

Chart: The bar chart breaks down the cost of investor behavior on returns: 20-years average index (S&P 500, 5.6%) and average equity fund investor (3.9%), with a behavior gap of 1.1%.

Studies done suggest that the investor return is often very different from the investments in which they choose. Investment results are often dependent on investor behaviors, not only which assets they choose but when they choose to invest and their decisions along the way to either add capital or to remove it. You’ll notice the numbers on our slide. A 5.6% rate of return, very competitive for the index itself. The average investor, unfortunately, earned a substantially lower rate of return, 3.9%. Now, we’ll examine some of the causes behind these poor decisions in a moment, but before we do, let’s put some numbers behind these behavioral differences to really understand their impact.

The cost of these bad behaviors can be meaningful, and our hypothetical example, we assume an investor adds $19,500 per year. That’s the maximum 401k contribution in 2020. We’re going to assume that that investor makes regular contributions to their plan for a 40-year time horizon.

Chart: The double line chart depicts the hypothetical portfolio difference between annual returns of 3.9% (average equity investor) versus 5.6% (the S&P 500): $920,848.

So, what if the investor earned the return of the actual market itself? The market return, the investment result was $2.7 million. The investor’s return, using the example from the slide before, was only $1.8 million. The difference in terminal value due to poor decision making, bad behaviors, was $920,000 or a 51% increase.

What are some of the biases that we find investors are often guilty of? We’ve identified three. Three among many that we’ll be addressing today. Loss aversion, recency bias, and anchoring. 

Let’s start first with loss aversion. It’s suggested that loss aversion is maybe the most powerful of the biases that we face. It’s premised around the idea that the pain of losses is twice as great as the pleasure earned in gains. This often prevents us from unloading an unprofitable position. 

A security that is down in value from our original investment, because we choose not to accept defeat, and we want to avoid the emotional pain that accompanies a financial loss. It also causes investors to take additional risk in an attempt to avoid pain from losses.

Sometimes we double down on an unprofitable position hoping that an eventual rebound will eliminate or reduce the probability of a loss. Here are some examples of loss aversion.

Chart: This chart looks at loss aversion and how it prevents investors from unloading unprofitable investments. It pictorially depicts two trajectory curves moving in opposite directions. In one direction, the trajectory curve of an increase in pleasure as $100 gains in value is a gentle upward slope. The chart that shows the trajectory curve of a decrease in value of $100 is steeper and shorter than the previous slope.

We invest only in safe vestments with low returns, which ultimately reduces our future purchasing power. There’s a cost to that safety.

We hold a stock that trades below its current purchase price simply in an attempt to avoid taking the loss for financial purposes. It’s the idea that the homeowner is unwilling to list their home for what is the fair market value because that value is less than what they may have paid for that house a number of years earlier.

The second bias that we’ll examine is known as recency bias or trend chasing.

Chart: The chart depicts a line graph overlaying a bar chart. The line graph shows growth of a hypothetical $100,000 investment increasing and decreasing from 2006 to 2008 for a portfolio created by an emotional investor (60% stocks, S&P 500/40% bonds, Bloomberg Barclays U.S. Aggregate Index); from 2008 to 2010 the line is increasing and is composed of 60% stocks (S&P 500) and 40% bonds (Bloomberg Barclays U.S. Aggregate Index) (LHS). The bar chart shows monthly net flows in billions into markets, consistent increases from 2006 to 2007, outflow in 2007, dramatic outflows between 2008and 2009, then more outflows before 2010.

It’s the idea that investors unfortunately fail to consider all of the different outcomes and opportunities before them. They make their decisions based on the trends that are afoot at that moment in time.

We weigh those datapoints more greatly than we do the entire universe of data. We have a tendency, as we feel good during bull market experiences, to add money, often near market tops, and as market declines occur, we become frustrated and emotions take over, and that fear concept causes us to liquidate assets often closer to market bottoms.

Maybe this concept of recency bias, adding money closer to tops, reducing our exposure at mark and bottoms, maybe this is the greatest or best explanation for the difference between investment and investor results.

Another concept is known as anchoring. It’s the idea that as investors, we’re often influenced by prior purchase points, price levels, or other data that occurred in the past. We cling to these numbers, these reference points, and we use them in making decisions as to whether to buy or sell.

Let’s take a look at the most recent example.

Chart: A chart explains what "anchoring" bias is (when investors are influenced by purchase points or arbitrary price levels) and how people behave. The accompanying line graph shows the performance of the S&P 500 Index from 2017 to 2020.

We know that many investors will be somewhat disappointed when they open their current statements, seeing a dramatic decline in asset values most likely since the peak of February 19th

You’ll notice that the S&P 500 peaked at 3386 on Feb. 19. The investor will use the most current statement and most likely compared their current balance against that prior peak. But what if we changed our reference point? What if we changed the datapoint to which we anchor?

For example, a year ago, on March 25th of 2019, the S&P traded at approximately 2800. And we anchored instead to a year earlier, the market bottom, at 2351, the investor, in fact, would not be facing a loss from that price point but a gain instead.

So, now that we’re aware of the impact of behavioral biases and some of those that exist and are most prevalent in investor decision making, what are some of the tools that are available to us to help mitigate the cost of bad behaviors? We’ve identified three.

We’re going to focus on understanding, behavioral risk, we’ll take a look at a tried and true methodology known as rebalancing, and then we’ll also introduce a new concept known as asset bucketing.

Behavior risk tolerance is important to understand as advisors,

Chart: The chart highlights eight questions that can be used to identify investors' behavioral risks.

after all, our clients have a financial risk tolerance, a volatility, a maximum loss that they can suffer financially, but the question I ask is what is their emotional tolerance in assuming or enduring risk?

Here are some interesting questions that may be helpful in the pursuit of better understanding your client’s behavioral risk tolerance. How has the recent volatility affected you? Has it changed any of your long-term personal goals? Are you comfortable with what you hold today, and if not, what specific changes might you be contemplating? If you received new money today, given current volatility, how would invest those dollars? What would be more important to you at this point in time? Regaining the value of your portfolio that was recently lost or protecting the capital that you still have today? How do you define risk? How do you measure it? And what tools or strategies do you use to manage it?

Hopefully these kinds of questions could be a great starting point for an in-depth dialog to demonstrate our empathy, our professionalism, our thoroughness, our willingness to do the work required to better understand our client’s concerns and to spend the time and the energy required to provide them with suitable recommendations.

Portfolio rebalancing definitely adds to return and helps to lower volatility, but maybe the greatest benefit of portfolio rebalancing is non-financial. It’s emotional. It’s the idea that portfolio rebalancing, when followed and implemented on a regular basis, instills a sense of discipline into an emotionally charged world. 

After all, rebalancing requires us to do what is emotionally uncomfortable but financially productive. Think about it. Rebalancing requires the investor to reduce their exposure to assets that have done well recently and to redeploy those assets into securities or asset classes that have done less well.

We provide an example based on the market returns in 2008.

Chart: The chart looks at portfolio rebalancing after market declines by comparing an initial allocation January 20008 of $1 million with an allocation profile in January 2009 and a reduced portfolio value of $753,605.

You will take a look at the hypothetical portfolio on the left, a $1 million portfolio divided across five different strategies: 30% in fixed income and 70% in different equity sleeves.

Take a look at the middle of the chart, the performance in 2008, and for those of you who were in practice back then, I don’t need to remind you of the fact that 2008 was a very disappointing experience. All four equity strategies in my hypothetical declined by more than 35%. The only asset class that held its value was fixed income.

Now, I’ll move to the pie on the right-hand side of the chart. You’ll notice a year later, as clients are revisiting their portfolio holdings in January of 2009, a 25% decline in their overall portfolio put a shift in the composition. 

Clients, based on their policy guidelines, are now underweight equities and overweight fixed income. What was the client’s temptation? Were they likely to rebalance their portfolios and to add money to equities at depressed values? If anything, many clients, in fact, were tempted to do the opposite, exhibiting frustration and disappointment with recent results, and in many circumstances, chose to move to cash.

A disciplined rebalancing methodology would have required this client to add money to assets that were undervalued by removing dollars from the asset class that did well. Now, please understand that rebalancing is not intended to be a market timing tool. There is no way to predict future asset classes and their resulting performance. Rebalancing helps us to guide clients through periods of emotional volatility, to instill discipline, and to help them increase the probabilities of successful outcomes.

Another strategy is the concept of asset bucketing. It’s a form of mental accounting. So, clients, of course, have various goals of different importance that occur at different stages in their lives, and when they look at their portfolio in aggregate, periods of volatility, like the one we’re experiencing today may be very concerning.

I need money to buy that second home. I have a short-term need and a desire for safety for the dollars that I’ll be using to educate my children. And so, when clients look at the total portfolio value and the volatility that we’re experiencing today, they may become dissuaded from embracing a long-term investment strategy.

But what if we took an approach that was somewhat different? What if we immunized by identifying different liabilities or goals to help our clients become more comfortable with the dollars that they set aside to satisfy those short-term goals while also allowing them to embrace riskier assets to produce the higher returns required to achieve their long-term financial goals.

Chart: The chart outlines a hypothetical asset bucketing strategy via client goals (buy second home [cash], education [mostly fixed income, some equities and alternatives], lifestyle [mostly equities, large portion fixed income, some alternatives], bequests [mostly equities, equal parts alternatives and fixed income]) a time horizon (from shortest to longest), dollar amount (all $1 million), priority level (high or low) and strategy.

You’ll notice four different goals that we’ve identified on our slide, the resulting time horizons, a hypothetical dollar amount, and then different bucketed strategies, different portfolio sleeves that each present different liquidity constraints and different expected rates of return to help the client become more comfortable in embracing an overall strategy.

Text on screen: Behavioral Guidance During Market Volatility
Presentation Goals: Market volatility and behavioral finance, the cost of bad behavior, biases during volatility, strategies to mitigate behavioral biases

Thanks for spending some with us to review our materials on behavioral guidance during market volatility. We hope that you found the material to be useful.

Text on screen: Advisor Education at PIMCO
Visit us at pimco.com/advisoreducation
It includes: White papers and blogs, resources to use in your practice, On-demand Continuing Education (CE), Comprehensive Curriculum outlining offering

We encourage you to reach out to your local PIMCO account manager to learn more about the resources that we’ve developed to support your educational needs and those that are available to support your relationship with your clients as well. Thank you for joining us.

Text on screen: Key Takeaways

  • Advisor action steps
  • Identify behavioral biases for your clients
  • Refocus clients on long-term goals and objectives
  • Consider various strategies to mitigate investor behavior such as: maintain perspective, stay diversified, rebalance regularly


Recorded on 27 March, 2020


Please note that the following contains the opinions of the manager as of the date noted, and may not have been updated to reflect real time market developments. All opinions are subject to change without notice.





All investments contain risk and may lose value. There is no guarantee that an investment strategy will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

This material contains the current opinions of the manager and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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