When stocks are rising and clients are following their uniquely crafted financial plan, everyone is happy. Who doesn’t like a roaring bull market!
But markets never rise in a straight line, and downturns, including violent selloffs, are a part of the investment landscape. We know they will come. We just don’t know when.
I recently had the privilege of talking to two financial advisors. Advisor A told me he’s had his clients in 90 percent cash since the start of the year. He doesn’t try to call tops or bottoms but hopes to exit and re-enter near market peaks and troughs. It sounds simple.
Advisor A said he anticipates a recession by mid-year. He plans to “nibble” at stocks following a 20 percent dip and get more aggressive when shares slide by 30 percent.
Advisor B takes a different approach. She recently commented to me that when it comes to market-timing, you have to be right twice: getting out and getting back in.
Advisor A did a good job of avoiding the turbulence at the start of the year. But will shares fall 20 – 30 percent? What if a recession doesn’t materialize and Advisor A’s clients are wallowing in cash?
Besides, aren’t investment plans crafted for the long term? Don’t they take into account market declines? Of course they do.
Let’s acknowledge something we all know: timing and side-stepping corrections is difficult, and it adds to both client and advisor stress when calls are wrong.
If clients are concerned, remind them that their long-term investment plan incorporates the unexpected potholes they will hit on the road to their financial goals. Tactfully explain that traffic jams and unexpected slowdowns are sometimes encountered on the journey to their financial goals. But over the long term, time is allotted for these delays.
As many of us have learned, a detour designed to save time usually costs time.
The annual study by DALBAR quantitatively illustrates the problems of forsaking a disciplined approach and opting instead for an emotional response to volatility.
Over the last 20 years, the S&P 500 Index has returned an annualized gain of 9.85%, which far exceeds the average equity investor’s return of 5.19%. It’s even worse when we go back over 30 years.
DALBAR highlights the primary reason for underperformance is voluntary investor behavior, which “generally represents panic selling, excessively exuberant buying and attempts at market timing.” These tend to occur during “market stresses,” DALBAR said.
If clients are unconvinced, it’s likely they failed to adequately understand their tolerance for risk and a mid-course adjustment may be in order. It’s a lesson some investors learn during a selloff.