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.