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Advisor Insights

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In choppy waters, keep an eye on long-term goals

When markets fluctuate, financial advisors can inform clients and reassure them that a properly diversified portfolio can weather the storm


Date: January 07,2015

When stocks tanked during the 2008-09 financial crisis, investors were left reeling. Even though the market eventually recovered, as it always does, many needed reassurance of that, someone to help them weather the storm. While taking steps to reduce financial risk, advisors also play a role in calming people’s nerves.

“In periods of great market volatility, people generally seem to feel better if you can explain what’s going on,” says Peter Drake, vice-president of retirement and economic research at Fidelity Investments Canada. “When investors understand what’s happening, it’s very helpful.

Mr. Drake, who frequently delivers seminars to financial advisors, often refers to a chart that shows the total return on the TSX since January of 1970. Updated most recently this past November, it shows a compound annual growth rate of 9.4 per cent over that period, even taking into account terrible periods like the recent recession.

“If you said to an investor, ‘Would you like an investment that will give you a compound annual growth rate of. 9.4 per cent over that period of time?’ Most would say, ‘Yes, that’s just fine.’

“But you need to ask a second question,” he’s quick to add.

“‘Are you prepared to lose periodically over that period perhaps 25 per cent or 33 per cent or even 39 per cent, as we saw in 2008 and ’09, and hang on till it comes back?’ Then some investors might not feel as comfortable.”

If knowledge is vital when it comes to holding steady during market downturns, so is structuring investments so that overall risk is reduced in the first place. Consider a medical analogy: By taking care of yourself and paying attention to symptoms, you’re stronger and better able to recover when a health problem appears. Think of sound financial planning as preventive medicine for portfolios.

Certified financial planner Dianne McCurdy, founder of Vancouver’s McCurdy Financial Planning Inc., recalls hearing from people from outside of her practice who were reeling from the economic crisis because of poorly diversified portfolios.

“We had people who were referred to us because they lost 60 per cent of their investments,” says Ms. McCurdy, author of How Much Is Enough? Balancing Today’s Needs with Tomorrow’s Retirement Goals. “There are stories of people who were in their 70s and retired and were 100 per cent invested in the market.

“The fact of the matter is that markets adjust,” she adds. “The worst thing is for someone to invest in a market, particularly an equity market, and be shocked and appalled when all of a sudden the market is down. And once the market has rebounded, you need to rebalance.”

Asset allocation depends on several factors, including investors’ timeline and risk tolerance. Accurately assessing someone’s capacity to withstand volatility, however, is often easier said than done.

“You can talk about it and talk about, but I have become convinced the only thing that teaches a person about risk tolerance is a loss or a severe downturn and seeing how they feel about it,” Mr. Drake says.

“Most good advisors will ask, ‘How would you feel if your portfolio dropped 10 per cent? How would you feel if your portfolio dropped 15 per cent? How would you feel if your portfolio dropped 20 per cent?’ That’s a difficult question for clients to answer if they’ve never experienced it, but it gets them thinking. If you understand this is part of the game, you are much better off than if it hits you as a surprise.

“You can use a baseball analogy for what the average investor needs to do,” he adds. “You need to aim for bunch of consistent base hits. Occasionally you may hit a home run, but if you get enough base hits you’re going to win that game. The problem is every investor has heard about a home run. I think that can be misleading, because that kind of investor probably isn’t talking about the times they struck out.”

Important for investors to understand as well is that different markets have different risk levels, Mr. Drake says. Equities have outperformed bonds since 2010, for example, but there have been times when bonds have outperformed equities.

“There is no right or wrong risk tolerance, but to get better returns you have to take more risk,” he says. “But the old saying stands true: you need to have a portfolio that lets you sleep at night.”

To do that, advisors must not only invest appropriately according to their clients’ needs and goals, but they must constantly re-evaluate portfolios so that, if and when markets do start to head south, people are able to hold steady. Frequent and clear communication also go a long way to calming investors’ nerves.

“Whether it’s 2008 or the recent choppiness in the market, I think as advisors we have to remember we’re the problem-solvers,” Ms. McCurdy says. “How do we solve the problem so people don’t feel panicky?

“When people call us, what they’re really calling for is reassurance,” she adds. “They want to know are they in right things? Is this normal? Should they be panicking? All that comes down to assessing clients properly on an ongoing basis.”

Being reasonable about projections and keeping an eye on clients’ long-term goals are essential for advisors as well.

“Don’t ever project ridiculous amounts you’re going to make,” Ms. McCurdy says. “Be realistic; even underpromise and overperform.”

“I tell my clients I have three rules: one is preservation of capital,” she notes. “Two is preservation of capital, and three is preservation of capital. Then we can look at return on capital. We don’t set ourselves up for failure, and we’re not going to hit it out of the park every time. We’re paid to take care of them not just when they’re investing money but with the big picture. We’re helping them have the future they want, to live the life they want and to have what’s important to them and their families.”

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