James Langabeer, PhD and Ryan Nauman, Market Strategist, Zephyr
The latest readings on consumer sentiment are sounding alarms across the financial world. While hard data on the economy can be negative, only when consumer optimism drops do we see a decrease in saving and spending. But, in recent months, indices such as the University of Michigan’s Consumer Sentiment Index have shown notable declines by as much as 13% since December 2024, reflecting growing pessimism among households. Freshly released data on Q1 gross domestic product from the Bureau of Economic Analysis showed a negative growth for the first time since Covid (-.3%), compared to +2.4% the previous quarter. The dollar is also weaker, and March’s inflation data was significantly higher than most economists expected. So it’s no wonder that all these data points continue to dampen the mood of most Americans, creating uncertainty. This uncertainty is also shown in the major stock indices, with trading volumes swinging wildly as investors and advisors make guesses about how the markets turn. In one day (April 4th), trading volumes on the S&P 500 were nearly double the historical daily average!
Overall, this uncertainty is creating consumer unease. While today’s data paints a sobering picture, the tools of behavioral economics suggest a more nuanced — and even optimistic — interpretation of what lies ahead, particularly for investors navigating turbulent waters. This article will discuss behavioral traps and how advisors can use behavioral economic strategies to lessen potentially damaging emotional choices.
Help Clients Recognize Behavioral Traps
There’s no doubt that emotional responses impact consumer behavior. Consumer sentiment reflects the current confidence level in the future, whereas the economic data are all laggard indicators. But they’re correlated, so a decline in confidence will drive changes in consumer spending and investing behaviors. Investors are not entirely rational; they make decisions based on these emotions, what we hear and see. This is called the wealth effect, a behavioral bias we see today where falling asset prices and negative news cycles reinforce each other.
Learn more about the most dominant emotion in investing.
Declining retirement balances and portfolio values can trigger loss aversion bias as well. As investors, we feel losses much more intensely than we would a similar-size gain. Seeing balances decline by even small dollar amounts can create significant tension. This emotional reaction can lead to hasty selling, further depressing markets and fueling a self-reinforcing loop between consumer pessimism and declining equity. As you can see in Figure 1, deep selloffs in equities correspond to decreasing consumer sentiment.
We also have to be aware of the impact of the availability bias. News cycles and headlines make things feel worse than they are. Individuals naturally give more weight to vivid, recent information, such as market downturns, layoffs, and price hikes, regardless of broader fundamentals about the underlying equities. This creates a feedback loop: as negative headlines dominate, consumer sentiment and investor confidence deteriorate.
Compounding this is herd behavior, where individuals mimic the crowd’s actions during periods of uncertainty. We certainly are seeing that today. When a critical mass of investors begins retreating from the market, it can create a momentum effect, lowering prices even when long-term fundamentals remain intact.
A recent research study by Zephyr shows that during times of heightened uncertainty like the Great Financial Crisis, the Covid-19 pandemic, and more recently in 2022, diversification breaks down when it is needed most. Correlations between traditional asset classes like stocks and bonds increase during times of crisis as everyone runs to the exits (Figure 2).
Using Behavioral Economics as a Source of Stability
Understanding these behavioral traps offers a pathway for more disciplined investing. Recognizing that emotional responses to volatility are somewhat predictable and typically exaggerated. Sharp sentiment declines and short-term market selloffs may not always reflect the longer-term economic outlook. Most economists are still predicting growth in the key indices by the end of the year, and long-term GDP growth is positive.
History offers support for this view. During the early pandemic shock in 2020, consumer sentiment and equity markets plummeted. Yet, fueled by rapid policy responses and behavioral resilience, markets staged one of the fastest recoveries in history, and we just came off one of the strongest performing years in market history. Those investors who stayed behaviorally grounded, maintained diversified portfolios, and avoided panic-selling were ultimately rewarded.
The Zephyr analysis below highlights the long-term impact of making short-term emotional decisions can have on investment portfolios. An investor would miss out on over $11,000 if he/she decided to liquidate his/her portfolio in March of 2020 and then reinvest in the same investment portfolio in August of 2020 (figure 3).
Interventions informed by behavioral insights can help prevent poor investment decisions. Financial advisors and individual investors can deploy “choice architecture” techniques to structure their decision-making process to favor long-term thinking: automatic contributions to diversified portfolios, pre-commitment strategies to prevent rash moves, and framing market corrections as opportunities rather than threats.
While a 10% pullback in stock prices can be tough to swallow and a cause for concern, mid-year corrections are common. Not only are mid-year corrections common, but they are also common during times of solid equity performance. Since 2005, the S&P 500 index experienced a correction (loss of 10% more) during the calendar year seven times. Of those seven times the S&P 500 ended the year with a positive return four of the seven. In fact, the S&P 500 index posted a +10% return three of those seven times (Figure 4). While unnerving, a correction doesn’t indicate a bad year is upon us, instead it can be an opportunity with the correct technique and strategy.
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Another hopeful perspective from behavioral economics centers on the power of narrative. People make sense of complex environments through stories, not spreadsheets. Today’s dominant narrative, one of persistent uncertainty, understandably fuels risk aversion. Yet, as new stories emerge about technological innovation, supply chain normalization, or productivity growth, they can shift sentiment and market direction surprisingly quickly.
Investors who focus on the evolving narrative instead of reacting to each headline can better maintain a rational, long-term perspective.
Actionable Advisor Strategies
By appreciating the human factors — our biases, fears, and behavioral patterns — investors can better prepare themselves to weather volatility without being driven by it. Here are eight actionable strategies that advisors can implement today.
• Proactively communicate. Keep clients informed by reviewing major market moves and sentiment data. This helps reduce uncertainty.
• Manage client expectations. Begin client conversation by acknowledging their emotions and listening carefully. Then, try to frame expectations around reasonable projections for 6 months or 1 year in the future, not tomorrow, using conservative estimates of market performance.
• Frame market volatility as normal and expected during significant policy changes.
• Anchor clients to long-term goals and emphasize that short-term volatility does not change long-term objectives.
• Use behavioral nudges to encourage habits such as automatic investing and rebalancing. Suggest small positive actions to keep clients feeling proactive.
• Highlight positive economic developments to keep perspectives balanced.
• Coach clients against impulsive moves. Also, be consistent in your messaging. Behavioral consistency strengthens trust and reduces anxiety.
• Finally, advisors, focus on remaining calm and staying self-aware by monitoring your own emotional responses to market swings.
Behavioral economics offers hope for helping clients navigate turbulent waters and stay focused on their long-term financial plan.
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Get James Langabeer’s book “The Quest for Wealth – 6 Steps for Making Mindful Money Choices” here.
James Langabeer, PhD, ChFC is a behavioral financial advisor, author of The Quest for Wealth: Six Steps for Making Mindful Money Choices, and managing principal at Yellowstone Wealth Advisors, LLC.