Record-level stock market volatility this year, including a near-7% drop on Thursday, has presented financial advisers with a live-fire test of how well they prepared clients to weather daunting economic outlooks.
For the most part, advisers say they are earning passing grades.
“My clients were calling us, but they were calling to see how we were holding up,” said Nadine Marie Burns, chief executive of A New Path Financial.
“I was totally surprised, and actually proud of our team that we had really worked with our clients and trained them well,” she added.
Burns said the key to preparing clients for sudden and severe market downturns is separating client portfolios into modules designated for longer-term and near-term needs.
“We talk about this all the time about setting up sleep-at-night-money, which is three years’ worth of money in very conservative investments,” she said. “We don’t work in the world of get rich quick and get poor faster.”
The S&P 500 Index, which is down 7% from the start of the year, is up 35% from a bottom reached in March after a 30% decline from a February high.
That kind of wild ride on the heels of a decade long bull market run might seem like the kind of thing that would send clients heading for cover. But a lot of advisers say they realized the good times couldn’t last forever so they spent a lot of time and effort preparing clients for the worst.
“Clients should have an irrational attachment to their money, and we should have a rational attachment to their money and those two things should come together,” said Nick Hofer, president of Boston Family Advisors.
When it comes to risk tolerance, Hofer said the tendency is to never get beyond the theoretical, which he compared to a $5 chip in a Las Vegas casino versus a $5 bill in your pocket.
“Most people look at risk tolerance along the lines of how much risk you can take based on market declines, but the problems occur when the market actually goes down,” Hofer said. “You have to get out of the theoretical, show them what down 30% looks like in their portfolio. Our job is to make sure clients understand the rational side.”
But according the 2020 Retirement Risk Readiness Study from Allianz Life Insurance Company of North America, not all investors are getting the memo when it comes to long-term investors and risk tolerance.
The report, which focused on retirement preparedness, found that less than 30% of Americans who work with a financial professional had discussed market risks.
The research also found that while six out of 10 non-retirees counted running out of money as one of their biggest worries, only 27% of those respondents who work with an adviser have discussed longevity risks.
Despite the Allianz research exposing gaps in adviser-client communications, there is evidence that investors in general are becoming more programmed toward thinking long term when it comes to their portfolios.
Even with consumer and investor sentiment falling since the outbreak of the COVID-19 pandemic, Cerulli Associates found that investors are predominantly focused on adopting a holding pattern for their portfolios.
“Advisers should be heartened by these developments, as the risk of people panic selling investments at the down point appears low, but this does mean that the money that was added during the good times should be prudently cared for so that it optimally serves clients’ long-term goals,” said Cerulli analyst John McKenna.
There is also the risk that a record-long bull market has lulled investors into a false sense of security that nothing can derail the upward ascent of stocks.
“I have way too many anecdotes of people throwing caution to the wind in the last two weeks, declaring victory that the economy is back to normal and the virus is basically over,” said Paul Schatz, president of Heritage Capital.
“These are the same investors who went to bonds in March,” he added. “It’s a behavioral finance homerun.”
That kind of shifting investor attitude toward market risk is why client risk tolerance must be monitored constantly, said Charlie Rocco, managing director at Moneco Advisors.
“Market volatility always calls risk tolerance into question, which is why it has to be managed all the time,” he said. “We’ve been saying to clients for years that recessions happen. We knew it was coming, but we didn’t know a crazy virus would cause it. I think that really helped center clients and remind them that they were ready for this.”