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.

I discuss the potential downside of the market in terms of percentages, but more importantly in terms of dollars. Talking about the downside in dollar terms is more tangible and less theoretical.

For example, let us assume we are talking with a prospect about a 70 percent equity portfolio for a million dollars. The historical “Worst 12 Month Period” for the Acropolis allocation is down 33 percent, or $330,000. I inquire about their ability, after a loss of $330,000, to remain invested and stick to the plan. I ask if they would lose sleep over that loss.

We talk through it. If they could not bear the loss of that much money, then we are taking too much risk and we need to adjust the plan.

Rebalancing
The most important principle in investing remains diversification. The second most important principle is maintaining your risk profile, which means rebalancing.

In 2008, I had a number of clients question why we were selling bonds and buying stocks. To many people this basic rebalancing step, which in better times we had discussed and agreed was prudent, seemed counter intuitive during the crisis. One client asked in 2008 why we were “buying stocks in a free-fall.” Last week that same client asked why we are selling equities and buying bonds.

We talked through it and I emptied his emotional trash can of media hype. He was back on the plan and we moved on.

I am not making a market call. I am doing what I said I would do; what I get paid to do. I am identifying a portfolio that today is overweight in equities and underweight in fixed income. To maintain the desired risk/return characteristics calls for rebalancing.

Rebalancing is discipline overriding emotions. It is simple, but not easy. At the time, it can feel like a poor idea. In the end, the process is rewarding because I can look back and see the pattern of buying low and selling high.

It Is Different This Time
Frequently a client or prospect parrots what they hear the media, that “It Is Different This Time.” I agree. It is always different, but it is not that different.

I observed differences in my son, my daughter, and my many nieces and nephews as toddlers. Each is unique; progressing through the stages of walking, talking, and learning to be potty trained in his or her own way.

Just like children, each cycle of the market is unique. They develop along similar times and lines, but they are not that different.

Summary
Emptying a client emotional trash can is a large part of an advisors job. Three common discussions I am having with clients are about:
•    long-term returns and short-term volatility,
•    rebalancing, not making a market call, and
•    why this time it is not that different.

Mike Lissner is a partner with Acropolis Investment Management LLC, a St. Louis based, fee-only wealth management firm, serving individual investors and 401k plan sponsors. Acropolis specializes in retirement planning and currently has over $1 Billion in AUM. For more information visit www.acrinv.com.