Global risk assets finally stumbled in the first half of 2022 after three consecutive calendar years of above average performance. This — along with tightening monetary policy, the Russia-Ukraine conflict, rapidly rising interest rates, and surging inflation — has roiled markets and rattled investor sentiment.
In volatile times like these, providing advice goes beyond asset allocation and retirement projections to include managing client behavior. In other words, helping them understand the potential risk of trying to time the market and stay focused on their long-term financial goals.
Risk of Trying to Time the Market
Market downturns are always unsettling, but reflecting on the market volatility in 2020 may help keep things in perspective today. When the S&P 500 Index experienced a sharp downturn on March 16, 2020, stocks dropped nearly 12% in a single day — one of the worst one-day returns in history. The uncertainty of a global pandemic and the risk of a prolonged lockdown made it easy to get caught up in the fear of a major correction. But investors who sold stocks in March missed the market rebound; the S&P 500 ended the year with an annualized total return of 77.58%.1
Trying to time the market usually comes at a cost. This is a critical message to convey to clients vulnerable to selling the dip — it’s simply impossible to know when exactly the market will hit bottom or when to jump back in.
Managing Client Expectations In Volatile Markets
Two client types in particular may be vulnerable to making poor investment decisions when volatility strikes: new investors and those nearing retirement.
Younger Investors Have Never Seen a Bear Market
Younger investors or those who started investing after the 2008 Global Financial Crisis have only ever experienced a bull market.
Source: Bloomberg Finance, L.P., as of June 29, 2022, based on SPDR Americas Research calculation. Past performance is not reliable indicator of future performance.
A bear market or recession may cause them significant distress, even panic. How can advisors help?
Discuss the concepts of risk aversion and loss aversion, and how these can bias decisions, to help strengthen their investment decision-making framework.
Review risk budgeting concepts, like opportunity cost and risk-adjusted return, to support more intentional decision making.
Whether your clients see the current market downturn as an opportunity to buy and hold, or they fall victim to chasing returns, will likely depend on your ability to steer them away from benchmark performance-focused discussions and toward decision-making that supports their long-term goals.
Mature Investors May Be Worried About Retirement
More mature investors, on the other hand, may be concerned about the timing of a downturn, or their sequence of returns risk. After all, clients nearing retirement or already retired have few or no income-earning years left to make up for large drawdowns. So when market losses are mounting, how can you help mature investors avoid panic selling? How can you help calm their fears?
It goes back to helping clients mindfully link risk to their goals, time horizon, and life stage, to take advantage of the value that portfolio construction delivers. Instead of trying to time the markets, consider creating an equity glide path that gradually reduces market risk as clients approach retirement or during their retirement years.
Having a plan in place that is designed to achieve their financial goals — regardless of unexpected market volatility — can help clients feel more confident that they’ll have the money they need to enjoy their retirement when they need it.
Because irrational behavior is an all-too-human trait, even among the smartest investors, it can be especially difficult to stay the course during a crisis or times of market volatility. That’s why an advisor’s role in emotional governance is critical to clients’ long-term success. And it’s why market volatility presents an opportunity for advisors to strengthen client relationships.
Value of Financial Advice When Volatility Strikes
For all types of investors, the key is to balance investment risk with opportunity risk in a way that reflects a client’s unique risk tolerance. Simply put, volatility is not the only risk to consider. It’s equally important to help clients make investment choices in context with their life situation. What is their investment horizon? What stage of life are they in? What are their financial goals?
During stressed markets, you can help reorient clients to the long-term outcomes they sought to achieve in the first place. And review how well-positioned they are to reach those goals. The best time, however, to start educating clients about potential risks and how you can help is early in the relationship and before market volatility strikes.
To help you engage in conversations that reinforce your value as an advisor — ones that help clients put risks in context, identify goals, and reveal biases that may make them vulnerable to poor investment decisions — check out the goals-based planning conversation guide below:
Goals-Based Planning Conversation Guide
Help clients look at the downside risk of an investment option separately from overall volatility, which can mask performance.
Introduce the idea of a portfolio budget to help incorporate risk where it‘s most likely to be rewarded
Frame performance discussions in terms of expected return per unit of risk
Help clients balance risk relative to return expectations to properly align asset allocation decisions with their actual risk tolerance.
Illustrate the opportunity cost and inflationary risk of holding too much cash
Review portfolio performance against priorities and long-term goals to fuel motivation and maintain focus on achieving outcomes
Discuss concepts like risk inversion and loss aversion — and how these can bias decisions — to help your clients become better-informed, more successful investors.
Review objectives and quantitative comparisons between investment choices
Frame decisions in a relative context to reinforce a thoughtful buy/sell discipline
Balance emotional quotient (EQ) with intelligence quotient (IQ) in investment decision-making to help clients achieve long-term goals at risk levels they’re able to tolerate.
Demonstrate empathy, listen actively, and show patience during the decision-making process
Look for opportunities to tailor investment solutions to clients’ personal situations, aligning plans with what’s most important to them (e.g., family, security, and independence) as a force for action
Volatility and market downturns may be inevitable, but they shouldn’t undermine an investor’s ability to meet their long term financial goals.
All the rational financial discussions in the world won’t propel an investor to their goals if they are not aware of their tendency to make decisions emotionally. That’s where you as the advisor can add value and, in the process, strengthen relationships with your clients.
More specifically, you can help them:
Become aware of and manage counterproductive biases and behaviors.
Focus on the basics and what clients can control in uncertain markets, things like portfolio diversification, regular rebalancing, and even tax loss harvesting.
Stay invested for the long-term, through periods of volatility or uncertainty. Keep investors focused on their long-term plan, which was designed to withstand inevitable market slumps. This will help them avoid counterproductive behaviors when volatility strikes.
1Bloomberg Finance L.P., based on daily returns since 1950 for the S&P 500 Index. Calculations by SPDR Americas Research. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. Past performance is not a reliable indicator of future performance.
The tendency of a market index or security to jump around in price. Volatility is typically expressed as the annualized standard deviation of returns. In modern portfolio theory, securities with higher volatility are generally seen as riskier due to higher potential losses.
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