There's no question that these are challenging times for investors and financial advisors. Okay, so a couple of nasty bear markets over the last decade and continuing talk of a modern day depression has dented confidence in the stock market, sending many investors into a deep portfolio freeze. The new era marked by bubble, crash, bubble, crash has not only taken a toll on personal wealth, but has also damaged investors' psyche. Furthermore, 3-5% intraday market swings and "flash-crashes" blamed on computer-driven momentum trading have made them lose confidence in a system that seems rigged against them. Now, their "portfolio paralysis" has rendered them incapable of taking risks and has kept you from serving them in their long term best interests.
More than ever, this tumultuous environment requires financial advisors to tap into their inner therapist as discussions with clients and prospects turn to why they should remain invested and why having as an advisor like you is still important.
Avoiding The Problem Is Not A Solution
You can start by assuring them that stuffing unopened brokerage statements in a drawer or hoarding all their money in cash is not the answer. Ben Bernanke has all but guaranteed that they will not make any money on their bank savings for quite some time when he declared that the Federal Reserve will keep interest rates at 0% until 2013. They have long-term goals of paying for their kids to go to college and retiring one day. Earning nothing on all their money for the foreseeable future won't help get them there.
Furthermore, turning a blind eye to their investments might be setting them up for some unintended consequences. Due to higher than normal market volatility and rapidly changing sector fundamentals, a portfolio that they thought was allocated conservatively might morph into an aggressive one. For example, those that thought they were invested for safety by having a portfolio largely made up of big, boring banks paying rich dividends in 2007 learned a painful lesson. Little did they know that their portfolios would get clobbered as the banks plummeted and slashed dividends in the financial crisis a year later.
You likely have heard prospects say they are waiting for their current investments to "come back" before making any changes. You might point out that after the 2008 crash, investors that hung on to their bank positions because they didn't want to accept a loss would have been better off selling after the initial rebound. While banks did have a strong run in the up markets of 2009 and 2010 as the economy recovered, they plunged again in 2011, leaving the big banks that survived the 2008 massacre much closer to their 2009 lows than their 2007 highs. Had investors diversified into other market sectors during the last two years their portfolios would have done much better. The lesson is that leaving a portfolio "as is" for long periods of time is a gamble they can't afford to take.
As for waiting until they feel comfortable with the direction of the world before making any decisions or changes to their portfolio, they will likely fall victim to the law of inertia. By the time the headlines make them feel good enough to take action they will likely have already missed the opportunity. Often when sentiment is the worst for an asset class is the best time for adding risk to that part of a portfolio.
Explain that the reason they feel so lousy in the first place is because the negative headlines have suppressed asset prices and their enthusiasm in the process. If things are not as bad as they are purported to be by the media then stock prices will likely rise. Use what happened over the last year in the municipal bond market as an example.
Last November, noted market analyst Meredith Whitney scared investors into thinking a massive wave of municipal bond defaults was imminent when she got on 60 Minutes to state her case. Her comments drove investors out of bonds, clobbering prices in the process. When her scenario did not pan out in the ensuing months, municipal bond prices rallied. Savvy investors should have thanked her for creating what turned out to be nothing but a good buying opportunity.
Getting Back In Control
You can help investors regain their mental edge when dealing with their investments by reinforcing the importance of having portfolio rules of engagement in place. This normally takes the form of an investment policy statement (IPS) that is established at the outset of a client relationship and reviewed periodically. This statement, which sets up the governing parameters of how a client's account will be managed, should outline a targeted asset allocation and the types of investments that can be made by the advisor. It will also give the advisor the flexibility to strategically and tactically overweight or underweight certain asset classes when market conditions and opportunities warrant.
Investors need to recognize that short-term emotion and impulsive tampering with a portfolio can do more harm than good over the long term. Among other things, they should think of a financial advisor as a buffer zone or line of defense between them and their money. The sooner they reduce emotional interference and implement a more methodical and objective approach to portfolio management, the sooner they can get back on the road to achieving their longer-term financial goals. A good advisor will get to know their clients personally and can better ascertain their individual objectives and threshold for risk when constructing the IPS.
Of course, this does not mean that advisors do not get edgy or feel the temptation to make changes when things get ugly or euphoric. We are humans too. However, we have to be much more disciplined about sticking to a plan, and therefore are better at tuning out today's headlines when making portfolio decisions. "Using an investment policy statement to rebalance portfolios helps take emotion out of the equation," says Michael Pompian, an author on the subject of behavioral finance. If done on a consistent basis, rebalancing is a mechanism that will force you to buy low and sell high.
At the outset of a relationship, you should inform clients how often they can expect you to review their portfolio and make rebalancing decisions. Do you review and rebalance regularly or when market conditions shift? Remind them that while down markets don't make for pleasant monthly statements they do give good fund managers the opportunity to pick up bargains that will result in better long term returns. Therefore, encourage your clients not to check their portfolio too often.
And for those clients with especially itchy trigger fingers, you might have to go into heavy duty therapist mode the next time they call and ask you to either "go all in" or "sell it all." Calmly suggest that if they think of their portfolio as a family member they don't get along with very well they will be better off. Remind them that in those situations it's best to limit their interaction to periodic doses so it will help keep them from saying or doing something they may regret later.
Steven Sheldon, CFA, has more than 17 years of professional financial and investment experience. He founded SMS Capital Management in Bellaire, Texas, in 2002.