As an advisor, one of the most important responsibilities you have–maybe the most important–is to ensure that your clients avoid making mistakes that will devastate their wealth. Of all the mistakes that investors make, the most egregious is the failure to maintain discipline.
The precise amount of potential wealth lost by investors due to lack of discipline is difficult to measure. However, it is intuitively obvious that moving in and out of the equity markets at the wrong time can destroy your potential gains from the capital markets. I was struck by a recent Forbes article (“Your Own Worst Enemy,” December 22, 2003) that estimated that investors who broke their discipline by jumping in and out of stocks have lost a whopping $1 trillion over the past decade. By contrast, damage to investors from the mutual fund scandals total around $10 million, Forbes estimates.
Don’t get me wrong. Fund managers who commit illegal acts should be held accountable. My point is that in the wake of all these scandals, it’s easy to forget that investors’ worst enemies are often themselves. That’s why one of your top priorities must be to teach clients what it means to be disciplined investors, and in the process keep them on the right path through thick and thin. By showing your clients how to become disciples of discipline, they’ll end up happier, wealthier, and very gratified with the value you provide–helping you to build a very successful business.
What Is Discipline?
Many clients are unsure of what it means to be disciplined, so it’s important for you to begin by helping them understand the characteristics of a disciplined investor.
For start-ers, a disciplined investor knows that inves- ting in the equity markets is long term by definition, and that the only way to reach your goals is to stick with a long-term game plan. Once a client has a diversified investment portfolio that reflects his or her personal profile–age, risk tolerance, financial situation, number of children, and so on–the only reason that portfolio should change is if the client’s profile changes.
Of course, most of your clients will agree that this approach makes sense, but often will find it tough to follow. The reason is simple. As humans, we feel the need to take action as events occur, thinking that we know how markets will react to those events. That’s why, for example, many investors cashed out of stocks following 9/11, or why I’m sure some of your clients are considering what moves to make depending on whether Bush or Kerry wins the election. It’s these types of changes prompted by external events that are responsible for investors losing $1 trillion in the past 10 years.
Disciplined investors, however, don’t make these mistakes. They never let events, market moves, or forecasts cause them to change their long-term investment strategy by moving in and out of the markets. They understand that the key is to stay invested at all times so they’ll always be there when the market return is positive. Like Woody Allen said, 80% of success is just showing up. Your clients need to know that all they must do to succeed in the capital markets is to “show up.”
When you explain discipline to clients in this way, it begins to look very appealing. So often the term “discipline” has a negative connotation because you must deny yourself something that you desire and enjoy–Atkins dieters need the discipline to avoid their favorite pastries and pastas, for example. Disciplined investing is different. The discipline that comes with being a long-term investor can be very satisfying, and not just when you achieve your goals: Relieving the daily anxiety and stress of the equity markets has it rewards as well. Disciplined investors don’t deny themselves anything that they would want to experience. Instead, they feel liberated by the fact that they no longer have to take action when the world at large changes. They get to focus their time and energy on what is truly important in their lives.
If you can find anything painful about that type of experience, let me know.
Stay in the Game
So how can you drive home the importance of discipline to your clients? Quantitative data can certainly help. You have all seen what happens to investors’ returns if they miss the market’s best performing days. For example, the chart at right shows the returns for the S&P 500 from 1991 through the end of last year. By simply staying invested in the market during that time, an investor would have gained 11.9% annually. That return plummets to 2.1% if he or she was out of the market for just the best 30 days. Of course, a quick review of that period–which included the September 11 attacks, the Russian debt crisis, and the Clinton-Lewinsky scandal–shows that there were plenty of opportunities for investors to break their discipline and damage their returns. This is what you must guard against on behalf of your clients.