From the November 2008 issue of Wealth Manager Web • Subscribe!


Most advisors (all good ones) start their clients on their personal journey to financial independence with a frank discussion about investment goals and risk tolerances. The carefully crafted allocation strategy that results will take into account the need for capital accumulation as well as a thoughtful assessment of risk tolerance, all with an eye on the eventual transition toward capital distribution when retirement becomes reality. It's a process for the long term.

But when markets get rough, advisors are inevitably faced with clients who panic. These clients are willing to abandon that solid long-term plan to pursue a short-term "safe haven" or, worse, whatever happens to be "hot." As a result, the advisor must often play the role of "behavioral coach" in order to save clients from their natural tendencies toward fear and greed. Left to their own emotional devices, individual investors invariably buy at market tops (greed) and sell out at market bottoms (fear).

A recent study using Investment Company Institute data through 2007 showed that asset flows into equity mutual funds peaked in 2001, right before 2002--the worst equity market in decades. The same study showed that asset flows to fixed income funds peaked in 2003, the same year the S&P 500 Index climbed more than 30%. The "hot dot" or the "flight to safety" rarely work out as expected. But they occur because the investor has lost focus.

Recently, fear has emerged as the dominant emotion in the marketplace. And that's precisely where advisors come in. If advisors are successful in imposing the requisite discipline on their clients and convincing them to stay focused on their long-term asset allocation plan, short-term stretches of volatility can be used to their benefit. Periods of economic uncertainty and market volatility offer the chance to rebalance portfolios, reassess risk tolerances (still in light of long-term goals, of course) and expand the opportunity set of available investment managers.

It's a near certainty that volatility will force one or more asset classes out of balance relative to the target allocation. This presents the opportunity to add assets to the underperforming asset class either through rebalancing or the addition of assets to the portfolio.

Reacting appropriately to market volatility also allows investors to review their true long-term tolerance for risk. Advisors can best serve a client in tough times by ensuring that a true shift in risk tolerance is taking place and not just an emotional reaction to recent turmoil. Otherwise, it's a good bet that the client will once again become more "risk tolerant" in the midst of the next bull market.

And don't overlook the opportunity to expand the investment manager set for asset allocation implementation. Certain managers have particular expertise in market sectors under stress, which provides for opportunities to rebalance in an intelligent way--not only by adding to assets where valuations are depressed, but by harnessing the talent of skilled players in the space.

Bottom line, this volatile market may well provide short-term opportunities for a long-term plan. But only if there's a process for the former and a focus on the latter. Don't panic about either.

J. Gibson Watson III is president and CEO of Prima Capital (, a Denver-based firm that conducts objective, institutional-quality research and due diligence on SMAs, mutual funds, ETFs and alternatives.

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