The hardest part of my job is helping clients deal with their emotional reaction to the market. Spurred on by a media which fuels hype, many clients oscillate between the feelings of fear and greed. As clients get a daily bombardment from the media, their investment trash can gets filled with rubbish.
Each hyped story adds a little more waste to the can. Periodically, as an advisor, I sit down with my clients to review the basics of investing. In the meeting I empty their emotional trash can and process the recycling.
Today, I smell greed.
More Stocks Please
As of writing this article on June 3, the S&P 500 is at a market high. For the better part of the past four years, the stock market has had an upward trajectory. Predictably, feeling bullish makes some clients want to increase their exposure to stocks.
So, I find myself talking with clients who think that we should be increasing equity exposure and decreasing bonds, which are paying very little interest. In 2002 and 2009 my job was to manage the “fear” gremlin. Now in 2013, as in 1999 and 2006, my job is to help manage the “greed” gremlin in each of us.
No Risk Questionnaire
At Acropolis we do not use a client questionnaire to establish a client’s risk tolerance because many people are too emotional. When thinking about their risk tolerance, the majority of people are more influenced by current market information and the tone of the media than changes in their personal circumstances.Yet it is changes to their personal circumstances that should drive any adjustment to the level of risk they should be taking in their portfolio.
The most effective way of establishing a client’s risk appetite remains Monte Carlo modeling coupled with a discussion about downside risks.
Effectively Discussing Risk And Return
The discussion of return is always about the long-term return. The discussion of risk is focused on the short-term volatility.
Regarding the long-term return, starting in 1926, the average return for large cap stocks is 9.85 percent. If the client brings up the S&P500 having an annualize return of over 22 percent (total return) since March of 2009, I reeducate and refocus on the long-term.
I stress the only way to receive the long-term average return is to also live through the short-term volatility. Therefore, when I talk about risk I focus on the short-term volatility.