When markets are volatile, some of your clients may be tempted to abandon their investment plans and flee to cash and low-risk alternatives. When markets rally, clients may want to dive into equities even though they’ve already missed out on the buying opportunity.
The onus is on you to help your clients navigate these short-term emotional extremes — and in the wake of Covid-19, your job has become even more important.
Every day, your clients are faced with headlines that may affect their better judgment. Whether the topic is the global pandemic, trade wars or the upcoming U.S. election, headlines can distract your clients — and it’s up to you to keep them thinking about the big picture.
“Clients need someone to listen to them and reassure them that they can weather the storm,” says Marie DeLauretis, a mutual fund representative with Desjardins Financial Securities Investments Inc. in Calgary.
After the pandemic struck, DeLauretis increased her communication with clients in order to understand the underlying causes of their fear.
“For a lot of clients, the panic wasn’t market returns; it was the job loss and uncertainty,” DeLauretis says. “Some lost their jobs and their income stopped. Businesses were halted and in jeopardy of closing down permanently.”
DeLauretis turned to educating her clients and reiterating the purpose of their investment plans, which already account for dips in the markets. “The point is their financial plan expects bear markets to occur. It expects those unwanted scenarios — whether they’re investment-related or life-related. I remind [clients]: ‘You haven’t lost until you’ve sold.’”
DeLauretis uses graphs to help educate her clients about previous downturns and what the markets looked like in the months and years that followed each downturn. “I say, ‘If I can tell you that [the market] will go back up — I just can’t tell you when or by how much — does that make you feel better?’ The more [clients] understand, the better they are at managing their emotions.”
Alexandra Horwood, director, wealth management, and portfolio manager with Richardson GMP Ltd. in Toronto, takes another approach. Horwood conducts a Lifeboat Drill — a process developed and published by Toronto-based EdgePoint Investment Group Inc. — with her clients at the onset of their relationship.
The drill compares the rate of return of large investment funds — such as Vanguard S&P 500 Index Fund — with the returns of average investors. In every case, the average investor performed significantly worse than the fund did. “[That’s] because they can’t control their emotions,” Horwood says.
When clients say they want to sell an investment, Horwood tries to make sure they aren’t panic-selling: “I never want it to be an emotional sale. I will tell them to sleep on it and that we can discuss it tomorrow, but we aren’t going to do anything today.”
Another element of Horwood’s approach is setting expectations with her clients early. She asks prospective clients to fill out a questionnaire that includes questions such as “What is your expected rate of return on an annual basis?” and “How much are you comfortable losing in a year?”
“These two answers have to align,” Horwood says. “During a market crisis, we can go back and see that [returns] are still within the constraints of what [the client] said they are comfortable with. If you set expectations from the get-go and your clients trust you, they probably won’t panic as much.”
However, a recent study by Chicago-based Morningstar Inc. found that investors are far more focused on maximizing their returns than financial advisors may realize. The survey participants said maximizing returns was a key part of the value of advice they receive and ranked other forms of advice — particularly those related to behavioural finance — much lower.
Furthermore, investors have high expectations regarding their returns. A survey from New York-based Schroder Investment Management North America Inc. found that investors around the world expected an average return of 10.9% over the next five years. Investors in the U.S. expected returns of 15.4%.
“Some people have a completely distorted reality of returns,” Horwood says. “So, I make sure to set realistic expectations.”
Horwood says she communicates to every client that the average annual market return is 4%–5%, and anything above that is “gravy.”
“There will be years when we get a 10% or higher return, but that is not normal. It’s a significantly outperforming year, and the next year the market could be down,” Horwood says. “I’m all about underpromising and overdelivering.”
While fear and uncertainty cause some clients to sell when markets are down, excitement can entice others to buy during a rally — but that can be just as dangerous.
Alim Dhanji, senior financial planner with Assante Wealth Management Ltd. in Vancouver, says his sister let her emotions run wild during the market rally that followed the Covid-19 crash, leading her to call Dhanji to ask how she could make money quickly in the stock market. “I said there is no such thing as making money in the stock market quickly. You can take a risk, but then it’s like gambling,” he says.
Dhanji’s strategy for his clients is the same one he uses for his own investments: be careful and have a diversified portfolio. “Diversifying is so important. Understanding your risk profile is so important. Trying to chase returns is the worst thing you can do,” he says.
Dhanji reiterates to his clients that investing is about time in the market, not market timing: “There are always going to be people who say they missed out on all these stocks. But at the end of the day, I’m not here to gamble with their money. And they usually understand that.”
Horwood’s view is similar. While she encourages certain clients to take advantage of a buying opportunity, she does so only with clients who have the “appropriate means” and risk tolerance.
“I always say if you are trading in the stock market, 50% of the time you are wrong and 50% of the time you are lucky,” Horwood says.
Horwood adds that her ultimate goal is to be a good fit for her clients and help them participate in the upside of the market while protecting them from risk — but those clients need to be a good fit for her as well.
“At the beginning, [prospective clients] are interviewing me, yes — but I am [also]interviewing them,” Horwood says. “I want to make sure it’s the right client for me and my team.”
Dhanji says he feels the same way: “As much as an advisor wants to take on a client, [the advisor] should realize the consequences if they can’t meet [the client’s] expectations.”