Financial advisors, more than anyone else, understand that the only thing certain about the financial markets is uncertainty. Yet many fail to properly prepare their clients for the harsh realities of investing. If you find that during this bear market your clients are reaching out to you in a panicked frenzy, ready to hit the eject button on their portfolio at any moment, you have not effectively prepared them for the volatility they are experiencing. As investment advisors, our job is as much about managing client expectations as it is managing client portfolios.
Since reaching their highs during the fall of 2007, the S&P 500 and the Nasdaq are down approximately 15% and 20%, respectively. But how often is this reflected in the conversations advisors have with clients? Many advisors tend to overemphasize positive investment performance, using it as the basis for initial meetings with clients and prospects as well as the selection of investment vehicles. Clients quickly become trained by advisors, who often cite historical average returns of 10% or more, that it is safe to assume that the clients' funds, too, will grow and prosper over time. Many advisors also make the mistake of presenting themselves as money magicians, capable of protecting clients from the pitfalls that can ravage a portfolio, by predicting the direction of financial markets. All financial professionals should be familiar with the efficient market hypothesis and random walk theories, which state that market movements are random, unpredictable and unbeatable. Yet advisors over-promise and under-deliver to clients time and time again. How can you blame a client who is counting on steady, positive returns for having heart palpitations when they are suddenly down 15% in less than three months?
More often than not when something occurs that was unexpected, panic ensues. This sudden, overwhelming fear can produce hysterical or irrational behavior that can interfere with the achievement of client goals. The key to managing client expectations is helping them to prepare for the unexpected. One of the most effective yet underutilized tools for managing client expectations is the investment policy statement (IPS). When used properly, an IPS provides the foundation on which an investment plan is built, serving to establish common goals and objectives between advisor and client. It provides documented guidelines for defining the asset allocation policy while establishing management procedures based on clients' objectives, time horizon and risk. A detailed risk assessment questionnaire used in conjunction with the IPS can help to clearly spell out the risks of loss associated with the particular investment objective selected, for example "growth with income." Notice it does not mention anything about clairvoyant market timing. When this is used properly, clients become fully aware of just how volatile markets can be and are not surprised when 15% of their portfolio suddenly disappears. They may not be happy about it, but they were prepared. Preparation is essential to limiting panic and minimizing the irrational decisions that may follow.
Ongoing communication is another key to managing client expectations and emotions. Advisors can never reach out to their clients too often. In fact, the best advisors understand that client emotions can vacillate as quickly as the market after an emergency Fed meeting. At times like these, advisors will be called upon to meet the various emotional needs of clients. When financial markets are cooperative and producing positive investment results, clients are quick to forget that negative returns may be just around the corner. In those good times, it is the advisors' responsibility to constantly reach out to their clients to prevent them from being lulled into a false sense of security. Someone has to play the role of the pessimist and remind clients to avoid deviating from the investment policy statement they created. By contrast, the turbulent times like those we are currently experiencing call for financial professionals to provide reassurance. Clients should understand that the advisor is not only there to help them make money, but in times like these, to help them lose less. They need to be reminded that the volatility they are experiencing is just part of the ebb and flow of the financial markets and that discipline and long-term vision are key to reaching their financial goals.
In essence, advisors must be cognizant of the fact that they are managing minds as much as money. Tuning into the emotional needs of clients is the key to helping them remain on track to realizing their goals and dreams. Preparation, full disclosure and some reassurance along the way will help clients to have realistic expectations about just how rough the road to achieving their financial goals may be.