Loss Aversion and Discomfort with Volatility in an Unpredictable Market

By: AnnMarie Pino

If the markets in 2020 have shown us anything, it is how unpredictable they are, even among professionals. Just 6% of financial advisors and 11% of consumers 55 to 75 years old thought it was highly likely there would be a major market downturn in 2020 according to the 2020 Guaranteed Lifetime Income Study (GLIS) by Greenwald & Associates and CANNEX.

Among consumers surveyed, just over half think a major stock market downturn is very likely at some point during their retirement. But historically, declines of 20% or more occur about once every six years.[1] While market declines will always be part of investing, those who stay in the market fare better than those who sell during downturns in the long run.

But what about investors who are particularly loss-averse or uncomfortable with volatility? These consumers—who have less invested in equities and higher cash holdings—need a way to invest for retirement that allows them to feel comfortable but also gives them opportunities for returns in order to have enough retirement income. With the market volatility due to the COVID-19 crisis, the unknowns of how and when the market will recover, and the Federal Reserve keeping interest rates near-zero through at least 2022[2], the portfolios of loss-averse investors and those uncomfortable with volatility need some help.

One potential option for these types of consumers could be guaranteed lifetime income (GLI) products. According the 2020 GLIS, both consumers and advisors believe benefits of GLI products include protection against the risk of stock market decline, providing a higher payout than other fixed income investments, and allowing owners to invest more of their other assets in equities to increase their chances for higher returns.

Data from the 2020 Study supports that these products could be ideal for these types of investors. Consumers who are loss-averse or uncomfortable with volatility:

  • See higher value in guaranteed lifetime income,
  • Are more interested in owning a GLI annuity,
  • Are more likely to agree that every portfolio should have money invested in product that guarantees lifetime income,
  • Are more likely to agree that advisors have a responsibility to present clients with GLI products, and
  • Are less confident they are withdrawing money in a sustainable way.

Despite this, these individuals are no more likely than those more comfortable with volatility or those less averse to loss to own an annuity—with or without GLI—and are less likely to have even discussed income strategies with an advisor.

Advisors can play a critical role in recommending GLI products to these types of investors. To do so, advisors need a way to easily identify these types of clients—and this solution needs to go beyond basic risk tolerance questionnaires.

Understanding how clients handle investment loss and volatility is important, both in terms of the financial decisions they make as well as how the cope emotionally during times of market instability or downturns. Updating risk tolerance questionnaires to better measure investors’ reaction to volatility, risk capacity, and risk need can help facilitate better portfolio construction that fits the needs of investors, including those who are loss-averse or particularly uncomfortable with volatility.

 

 

Want more on the 2020 GLI Study? Read the top 10 Key Findings from the 2020 GLIS or find out how to get the complete study reports here.

[1] Capital Group, March 4, 2020. www.capitalgroup.com/ria/insights/articles/how-to-handle-market-declines.html

[2]Federal Reserve, June 10, 2020. www.federalreserve.gov/mediacenter/files/FOMCpresconf20200610.pdf

Careers Greenwald & Associates