Dollars & Sense Blog Series
Tariffs and Volatility: A Focus on Behavioral Finance
By Hayden Porter, CFP®
Wealth Advisor
Recent tariff announcements and the resulting economic uncertainty have triggered significant market volatility, leaving many investors wondering how to respond. At Obermeyer Wealth, we view this situation through both a tactical and behavioral lens. While the size of the proposed tariffs was larger than expected, the direction itself aligns with our expectations. More importantly, we recognize this as an opening move in what will likely be a dynamic negotiation process—not a final policy outcome.
Market Context: Today’s Volatility & Historical Perspective
The current market reaction reflects both the immediate policy shift and underlying investor concerns about elevated market valuations.
To place the current situation in context, it’s helpful to understand the relationship between market returns and volatility:
- From 1990 to 2024, the S&P 500 has delivered an impressive average annual return of 10.5%. However, this performance has been accompanied by an average intra-year drawdown of -14.1% during that same period.
- In the current year, the S&P 500 has experienced a year-to-date return of roughly -10%, with the largest intra-year drawdown of -19%.
These statistics highlight an important truth about investing: significant gains rarely come without periods of volatility. What appears as a smooth upward trajectory in long-term charts actually contains numerous short-term declines that tested investor resolve.
Volatility is the Norm, Not the Exception
Market fluctuations are an inherent part of investing, not necessarily a sign that something is broken in the economy or markets. A key differentiator in investment outcomes is how investors respond to these inevitable periods of uncertainty. “Success” for most long-term investors is less about timing the market and more about time in the market, and maintaining discipline during volatility is essential to capturing enduring returns.
Behavioral Finance: The Real Challenge of Volatile Markets
During uncertain periods like the one we’re experiencing now, understanding behavioral finance can be just as critical as portfolio construction. Several common psychological tendencies can undermine even the most carefully designed financial plans:
Loss Aversion and Short-Term Thinking
Investors typically feel losses twice as intensely as gains, which can lead to poor timing decisions. Consider this: if offered a guaranteed $100 or a coin flip for $250 or $0, most people choose the sure thing—$100. This fear of loss intensifies dramatically in volatile environments like the one we’re navigating now.
Recency Bias
Recent market events often feel more predictive than they actually are. The current tariff situation may seem like it will permanently reshape markets, but history shows that policies evolve and markets adapt. This bias can cause investors to overweight or underweight certain sectors based on immediate headlines rather than long-term fundamentals.
Hyperbolic Discounting and Market Patience
Another behavioral finance cognitive bias, hyperbolic discounting, reveals how context influences decision-making, especially around delayed gratification. Investors who trust their environment are more willing to wait for greater rewards. In investing, this translates to confidence in the system.
When markets feel unpredictable, like during periods of volatile policy shifts, investors become more present-focused and less willing to delay gratification for future gains. Today’s climate has made many reluctant to play what is ultimately a high-stakes patience game, potentially sacrificing superior long-term outcomes for immediate comfort.
Strategies for Navigating Volatility
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Diversification & Asset Allocation: Foundations of Risk Management
Our approach to portfolio construction spreads investments across various asset classes to reduce volatility and smooth returns over time. While tactical adjustments have their place, staying anchored in a strategic allocation helps prevent reactionary shifts that derail long-term plans.
The historical data on market drawdowns demonstrates why this approach is so important. Even in years with positive overall returns, investors typically experience double-digit percentage declines at some point during the year. A properly diversified portfolio helps moderate these swings, making it easier to stay invested through the inevitable rough patches.
The current tariff situation reinforces the importance of global exposure and non-correlated assets. Including international equities, fixed income, and alternative assets can buffer against U.S.-centric policy shocks.
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Rebalancing & Tax-Loss Harvesting: Turning Volatility into Opportunity
Market disruptions create opportunities for disciplined investors. Tax-loss harvesting during downturns can reduce taxable income while repositioning portfolios for long-term growth. Our systematic approach to these strategies removes the pressure of emotional decision-making during stressful times.
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Liquidity Planning & Emergency Reserves: Avoiding Forced Selling
Having adequate liquidity for short-term needs prevents panic selling during downturns. Our bucket strategies segment assets by time horizon, allowing investors to mentally and financially weather volatility without compromising long-term allocation strategies.
Conclusion: Long-Term Success is Largely Behavioral
Volatility is inevitable, but panic is optional. The historical data proves this point: the average S&P 500 investor has endured a -14.1% drawdown in a typical year since 1990, yet the index has delivered average annual returns of 10.5% during that same period. This year’s -19% drawdown and -10% year-to-date performance fall within the historical pattern of market behavior.
Investors who prepare for these inevitable downturns and understand their own biases are better positioned to stay the course. Discipline is a true differentiator in investment success.
As DataTrek notes, “Staying in the game builds both market skill and mental resilience. When markets calm down (and they always do), you’ll be better prepared to profit over the long run.”
At Obermeyer Wealth, we’re committed to helping you navigate both the financial and emotional aspects of investing through all market cycles. If you have questions about your portfolio positioning or would like to discuss your specific situation, we’re here to help.
Please reach out to our team if you would like to learn more about this service we provide to our clients.
