Over the past three and a half decades as a financial advisor, I have experienced my fair share of difficult markets, along with my clients. While these periods are painful, they are a natural component of market cycles. Since the Great Recession in 2008-2009, we have experienced the longest and one of the most historically robust bull market cycles in over almost 100 years. Investors have understandably forgotten what an ugly stock market is (on top of simultaneously experiencing the worst bond market since 1949).
While financial academics form the basis of our advice, consideration of our clients' "financial baggage" is key to helping them maintain an appropriate long-term investment strategy. I define financial advice as providing independent guidance to clients that combines the academic discipline of a well-structured portfolio with a client’s financial goals and risk palette, which is an easy enough sentence to write, but getting there involves both "art" and science. Investment management is not a knowable exercise in real time. It is not based solely on tried-and-true academic equations that are solvable and static. Yes, academic discipline forms the basis of underlying investment strategies. However, each investment cycle has particular factors that affect the current markets, which are considered in the context of past cycles with similar asset class relationships and correlations. These relationships and correlations can shift and change so academic considerations are fluid and need tending. The reality is that investment results are based on the probabilities of future outcomes that are unknowable in the present but are considered based on historic data, expectations, and precedence.
So, what do you tell your clients about what is likely to happen now and in the future? You tell them the truth and educate them.
The truth is that no one knows what is going to happen and when. I spent decades of my career interviewing asset managers and listening to investment strategists, most of whom had very impressive credentials from top tier firms. The net-net of all that time spent is that no one has a crystal ball. If they did, then one person/firm would be featured on CNBC every day or use their clairvoyant skills to manage their own portfolio from the beach. The media must fill the airwaves and print copy, so these views can be easily mistaken as having real knowledge. This perception, based on mountains of available information, has perpetuated a subliminal impression that someone, somewhere has the answer.
In working with individual clients, it is most important to be goal-oriented rather than focusing solely on performance relative to benchmark returns. It is more important to "do no harm" than to put financial wherewithal at risk. A financial plan plays an essential role in quantifying, with a high level of confidence, whether a client's financial goals are achievable and, if not, what it would take to increase the probability of being able to sustain their desired lifestyle. It provides important input regarding various long-term expected investment returns and associated risk profiles and informs our discussions with our clients about asset allocation. Research has shown that the asset allocation decision – what percentage of a portfolio should be invested in stocks, bonds, cash, and other strategies – is the main determinant of risk/reward. This decision dwarfs considerations about what individual stocks to buy, for example.
Establishing an appropriate asset allocation for a client that reflects their long-term objectives and risk appetite, and from there, what asset classes and investment strategies "belong" in a well-diversified portfolio, forms the basis of the academic "science" of advisory services. However, time needs to be spent listening for, asking about, and appreciating a client's individual reaction to risk, which I define as paper losses in real time and the associated feelings that are triggered. If those emotions can be known and acknowledged, an advisor can make a meaningful difference in the long-term success of their client's financial well-being. Knowing your client, communicating with them, and educating them are the human ingredients needed to effectively help them navigate difficult markets and personally challenging periods in their lives. They expect us to be steeped in the academic, but feel particularly supported by our understanding and consideration of who they are and what they care about.