Is it my imagination, or have securities litigation firms been hiring a lot of people lately? Why are they “arming” themselves? Is there a battle happening that I’m not aware of? Or is there a war on the horizon? Unfortunately, I suspect the latter. Let me explain. When the value of your investment clients’ retirement portfolios is rising, your clients oftentimes think that they are either lucky or smart. That is, they sometimes don’t give you the credit. But when the economy suddenly tanks and their portfolio values take a nosedive, then suddenly it’s your fault. Your clients might even try to sue you. Sometimes they will file a class-action law suit, where the lead plaintiff will be a retired couple that’s been married for over 50 years, where the husband is a retired factory worker or a military veteran and the wife is a retired schoolteacher or librarian. In their deposition, they will talk about how hard they worked their entire lives to save for their golden years, but suddenly you, as their financial advisor, lost one-third of their nest egg. You may feel like you won’t stand a chance in front of a jury, so you and your attorney decide to settle the suit, even though you did nothing wrong.
I know this scenario is how it can play out, as I previously worked as a special consultant and as an expert witness for a securities litigation firm, and I also worked as a senior financial economist at the U.S. Securities and Exchange Commission in Washington, D.C.
So let me go back to my original question. What battle is lurking on the horizon? Interest rates are likely going to rise. After all, they cannot go down much lower. And with the Fed finally cutting back on QE and possibly abandoning it later this year, it can facilitate the interest rate rise. This means that the values of traditional equities and bonds, especially long-term bonds, are going to take a bit of a hit.
Normally, when you have your older clients in bonds, you are trying to protect them, you are trying to be prudent, and you are trying to be a caring advisor. But now is the time to take a look at the bonds that your older clients are holding. Are they long-term bonds? If so, then their values could take a large hit when interest rates rise. For 10-year bonds, if interest rates rise by 3 percent, then the value loss could be about 25 percent. But what can you do? Put your older clients’ assets into short-term bonds? If you do this, then won’t your clients wonder why they are paying you for such small returns? Of course, there are many possible solutions. One could be having your clients invest in short-term high-yield bonds that can be diversified across many industries. There are many other possibly good solutions as well. Think about those possible solutions now. Be armed and protected. There may be a war on the horizon. Make sure you are watching from the outside, rather than getting caught in the middle of the cross fire as an innocent victim.
Kenneth A. Kim is chief financial strategist for Eqis, which provides asset management, practice management and operations automation on an integrated platform for advisors.