In this ongoing series, we provide our readers with two distinct perspectives on the same topic — one from an academic, the other from a practicing financial advisor. In “The Advisor and The Quant,” we will pose one specific question to the advisor and the quant. You will see their responses here on ThinkAdvisor.
If you have a question or two, please send them to us.
QUESTION: How can advisors use market volatility to build client trust?
THE ADVISOR — JOE ELSASSER, CFP, PRESIDENT, COVISUM:
One of an advisor’s primary roles in a client relationship is to overcome common behavioral biases. A very powerful bias is often referred to as recency bias — an expectation that events of the recent past are likely to continue into the future.
When the market is up, such as the smooth and steady increases we’ve seen over the last few years, clients can be lulled to sleep and because the last significant market dips are a distant memory, they fail to monitor investments or rebalance. Instead, they expect the good times to continue. When we get a market correction, like we did early in February, the possibility that we’ll see another massive recession can drive investors to sell out — anticipating a panic.
Neither believing the market will continue to increase nor panicking when it has a dip is healthy for a client’s long-term wealth. As an advisor, setting realistic expectations for clients and coaching during good markets will help level-set the impact of a down market, if and when it occurs. Good investment practices, such as rebalancing, shouldn’t be ignored and with proper downside expectations, clients can still reach their financial goals, even through the next correction.
Ultimately, market volatility is the reason for a financial plan. When an advisor and client have developed a financial plan in advance, the discussion can remain focused the client’s ability to meet their financial goals, preventing the greed/panic cycle that causes most investors to underperform the market as a whole.
THE QUANT — RON PICCININI, PH.D., DIRECTOR OF PRODUCT DEVELOPMENT, COVISUM:
Trust is earned when the client’s experience is in line with the expectations you set for them. When markets experience bouts of volatility, it is a perfect time to showcase your expertise and revisit the portfolio downside expectations previously set.
Show the numbers.
For clients in defensive portfolios (and thus minimal paper losses), it may make sense to demonstrate how little their portfolio value changed vs. the overall market. It shows that your risk strategy is working as planned.
For clients with aggressive portfolios, it may make sense to remind them that the source of higher long-term returns is their willingness to stomach the ups and downs of the market. The reward for investors who can deal with anxiety-producing price volatility is greater profits. There is no free lunch.
Ideally you have done your homework before spikes of volatility.
Advisors who will truly shine through the process will have already set realistic downside expectations with their clients, when times were good. Now that volatility has kicked in, it is a great time to dig up the report showing how much downside your clients signed up for, as well as their risk tolerance questionnaire. For example, if a client indicated that they would be OK with losses of 10% in a quarter, and their portfolio is up (or down) 5% for the quarter, it will give them confidence in your investment strategy.
Think like a computer.
Showing that a client’s portfolio losses are in line with past market fluctuations will move the discussion from the emotional to the rational. It is nearly impossible to make good decisions when driven by emotions, especially fear. How is the economy doing? Are forward earnings increasing or decreasing? Is the market correction something that we have not witnessed in the past 20 years? There is seldom anything new in the markets. The recent bout of volatility has happened countless times before, therefore it should not come as a surprise to an informed, rational-thinking investor. If it’s business as usual, there is no reason to change the process.
Joe Elsasser, CFP, RHU, REBC developed Social Security Timing software in 2010 because, as a practicing financial advisor, he couldn’t find a Social Security software that would help his clients make the best decision about when to elect Social Security benefits. Through Covisum, Joe introduced Tax Clarity in 2016.
Based in Omaha, Nebraska, Joe co-authored “Social Security Essentials: Smart Ways to Help Boost Your Retirement Income.”
Renaud “Ron” Piccinini, Ph.D., came from France to America, finally settling in Omaha, Nebraska. He brings extensive experience in building world-class risk systems, supporting tens of billions of dollars in assets to Covisum. Previously, Ron co-founded PrairieSmarts, a software business. Ron wrote his dissertation on what are now known as “Black Swan Events.”