Do all stocks go up? Years ago, when I was an advisor in Brooklyn, N.Y., it was the time many Eastern Europeans were emigrating to the United States. They were leaving countries with persistent high inflation. Some assumed the same logic applied to investing. They thought all stocks went up, the only difference was some went up faster than others. Do your clients understand risk?
Here’s another anecdote. Years ago, I was listening to NPR. They would report market action on two of the big three stock market indexes as part of the news at the top of the hour. A caller asked why they did that. “The stock market going up isn’t news. It’s supposed to do that.” There are probably people who think the same thing today.
Six Lessons About Risk
You might feel like Debbie Downer making some of these observations, but they need to be put out there.
1. Percentages matter. If a stock declines by a third, it needs to rise by 50% before the client is back where they started.
2. The foolishness of selling winners. People like to take profits and feel foolish when they lose money. Consider buying five stocks. Four go up, one goes down. You sell the winners and buy three more. Three go up, one goes down. You sell the three winners and replace them. Two go up and one goes down. You sell those two winners and buy two different stocks. If one of those two goes up, you then realize you are left with four losers in your five stock portfolio.
3. Diversification isn’t what you think. Back before the dot.com crash, there were people who thought they were diversified because they owned five different dot.com stocks. That’s industry concentration, not diversification.
4. Look under the hood with mutual funds. Funds are often classified by size, style and sector. Your client might think they are diversified if they own five large cap growth funds. If those funds are similar, they may each own the same stocks among their top five holdings. Your client isn’t as diversified as they imagined.
5. Success isn’t only justified by the return. Your client might invest elsewhere too. They are thrilled with their overall return. How much risk did they take to achieve that return? You can probably find a way to chart this and make the case to them. Higher risk usually involves higher volatility. It’s fine to accept a lower rate of return overall if the risk level can be substantially lower.
6. Don’t buy things you don’t understand. Many people hear about an investment from a friend and say: “Buy me some of that.” You need to understand what needs to happen for the investment to do well. Most people can have a little play money set aside, but you shouldn’t put serious money at risk. As one of my clients once said: “I need to know what I’m cheering for, what has to happen.”
These aren’t things clients want to hear. They might dismiss them as common sense. Bringing them up will show clients you are paying attention and have their best interests in mind.
Bryce Sanders is president of Perceptive Business Solutions Inc. He provides HNW client acquisition training for the financial services industry. His book Captivating the Wealthy Investor can be found on Amazon.