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The recent bloodshed across all financial markets and the eventual impact of those struggles on individual investors’ portfolios have created many doubts on the ability of financial advisors to get their clients through these tumultuous times.
The question remains, If advisors aren’t paid (rather handsomely, I might add) to keep their clients out of trouble, what are they paid for? Aren’t accountants and attorneys hired (and fired) based on their ability to provide a service to clients that will keep them on the smooth path? Aren’t professionals, of any kind, hired to avoid the turmoil one would expect without the hiring of said professional?
Yet, for many, these expectations were not met in the fall of 2008 and the spring of 2009. And time will tell if the financial clouds will re-gather for a longer, and more intense, encore.
The responses from advisors have been exactly what one would anticipate. “Stay the course.” “These downturns are just part of investing.”
And, to some degree, these advisors’ replies have been legitimate. When an investor takes risk, he/she should expect some sort of bumps along the road. But how deep and wide should one expect?
Ask an individual preparing very soon for her retirement about these advisors’ casual retort to a portfolio loss of a couple hundred thousand. How is this individual supposed to “stay the course” when the funds they have been deferring into their company retirement plan are gone? Now what? Should this individual further expose his/her portfolio to more loss? Should he or she quit deferring into the company retirement plan that has revealed itself to be so vulnerable? Should they now re-allocate their funds more conservatively, thereby accepting the losses received? These are tough questions that may have equally tough answers as investors navigate through very unusual times.
But again, aren’t advisors well-compensated particularly for these times? Thomas Paine’s statement in “The Crisis” sums up this financial era that we found ourselves in recently. Not to overstate the importance of an advisor’s role in his client’s life, but these are the times that try financial advisor’s souls.
So, what should advisors have done? What specifically should advisors have done?
My answer is twofold.
Let’s look at the first one first. In precious few situations, should an investor (especially one nearing retirement) have more than one-half of his/her portfolios allocated to equities, or stocks and stock mutual funds. There is a certain amount of stocks and stock funds that should be a part of an investor’s portfolio. But to depend on stocks during retirement to sustain a portfolio is too risky and should be reconsidered. In fact, stocks should no more be depended on than Government Bonds, or Gold.
Which leads us to our second point, diversification. True diversification is the process of combining a portfolio in a way that reduces correlation (think parallel links) with any one asset class. In other words, when the stock market plummets, your portfolio shouldn’t.
To achieve this, an advisor should be combining asset classes together in a way to dampen the daily, monthly or annual effects of short-term losses, even collapses.
For years, advisors have sliced and diced portfolios in ways that would make diversification appear to be present. However, when deeper investigation is done, many of the asset classes that make up the portfolio have been very similar and have dropped similarly in value when enough market pressure is exerted on these portfolios. Large cap, small cap, mid cap, value, growth, and blend may seem to give diversification to a portfolio, but at the end of a day, they are all stocks and are essentially subject to similar risks.
Instead, advisors should have and still should create stronger portfolios for their clients. These portfolios should be more resilient in the way they stand up to a variety of market forces by combining VERY different asset classes. The more different these asset classes are, the more different they behave in times of stress. This is the idea of true diversification.
So, what will advisors learn from the recent near-catastrophe? Hopefully, a lot. The good ones will learn that risk is always present. They will learn that their clients, especially ones nearing retirement, can’t accept much in the way of said risk. Like other professionals, they will find ways to avoid catastrophe for their clients.
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