Paul de Sousa, senior vice president at Sightline Wealth Management, who leads the firm’s private wealth team, suggests financial advisors start by doing a sensitivity analysis. This “what-if” analysis looks at what kind of shocks the portfolio can withstand without it affecting the client’s annual withdrawal rate and long-term income projections. Then, make adjustments as necessary.
Afterward, take time to explain the results so clients understand that their retirement income stream will be unaffected by an economic downturn and possible market impacts. Having the discussion now may stave off panicked reactions later.
“You can show them that their portfolios can withstand, say, a 15% shock and they can still withdraw the amount they planned to and it won’t impact their retirement,” says de Sousa. “They still have money at age 95.”
Depending on the client, these analyses can take some time. de Sousa reiterates to conduct these analyses now since it’s impossible to predict recessions. “There’s a lot of calm and peace knowing that when there’s blood in the streets and CNN is blaring about how everything is falling, you know ahead of time what will happen given a certain rate of return,” he says. “There’s no better strategy than to have done that, but you can’t do it in the midst of a crisis.”
Diversification Is Key
The first quarter is the traditional time to rebalance and diversify holdings, and given last year’s rallies in almost every market, most portfolios are likely imbalanced. But explaining why clients need to diversify and rebalance is easier said than done, says Chris Battifarano, chief investment officer of FineMark National Bank & Trust.
The past decade has not rewarded diversification, as the S&P 500 has outperformed many other sectors, including small caps and international markets, he says, and that’s twisted some people’s view of investing. People are questioning the need for diversification in other markets based on recent history, but that’s a mistake.
“If you think there will never be a recession again and the U.S. is the strongest market in the world, then don’t diversify. Be long U.S. large caps,” Battifarano says. “But we don’t believe there’s been some permanent sea-change in the world. Diversification is the key to building a more robust portfolio that can weather drawdown periods, whether they’re recessions or bear markets.”
To Battifarano, diversification means investing across the spectrum in equities, both in market capitalization and geography, but also in traditional fixed income.
In fixed income he looks both at investment grade and high-yield markets, but also what he calls “opportunistic credit,” such as mortgage-backed securities and other investments that have a slightly different risk exposure than traditional fixed income.