Quiet summer for investors? not so much. China unexpectedly devalued its currency, signaling that its exporters may need help to maintain growth. The markets tumbled, and there’s less certainty over when the Fed will raise interest rates. Added to that, oil prices have dropped to their lowest point since 2009, and there is real potential for ongoing volatility.
So it was ironic that “Handle With Care” by the Traveling Wilburys was playing in the café I ducked into for coffee before I started to write this column. The first line, “Been beat up and battered ’round,” seemed to describe recent events. While our clients understand that their diversified portfolios are built to withstand market swings, their emotions may sometimes get the best of them.
I use the following techniques to reassure clients and keep them focused on the long term:
1. Get out in front of the crisis. When volatility strikes, it’s important to reach out with information and reassurance. Therefore, on Aug. 21, a Friday afternoon, I sent an email to all clients and prospects in which I answered questions about the impact of recent market events on client portfolios.
My conclusion: “Our investment approach has not changed as a result of this news or the volatility in the markets. We emphasize the importance of broad diversification, efficient portfolio design and execution, and consistent asset class exposure as the most reliable means of capturing market premiums that can offer investors higher-than-expected returns and minimizing downside risk.”
2. Combat a fear of numbers with more numbers. Big losses in the headlines have a way of fueling worry. Going forward, I’ll remind clients of 2011 when the Dow fell 635 points on Aug. 8, a Monday, only to rebound 430 points the next day. That was followed by another 520 point dive on that Wednesday and a Thursday increase of 423 points. While past performance is no guarantee of future results, historical performance does illustrate that we’ve experienced similar volatility before and eventually recovered.
My bottom line is that the markets reward discipline. For example, one dollar invested in the MSCI World Index (net dividends) in 1970 is worth $45 today. This is true in spite such events as the oil embargo and S&P 500 drop of 45% in the 1970s, the dot-com bubble, the subprime mortgage crisis and the government’s fiscal cliff crisis.
3. Appreciate that there’s no greater fear than the fear of the unknown. As trusted advisors, we need to be sure that clients have the ability to move forward in a positive way in spite of the uncertainties in the current market. Will the volatility continue? Will the Fed raise rates? We don’t know, but we still need to stay committed to our plan.
To remind myself of the decision paralysis investors face when the environment is so uncertain, I often review an experiment conducted by the renowned behavioral finance researchers Amos Tversky and Eldar Shafir.
They asked three groups of people to imagine they had just played a game that gave them a 50% chance to win $200 and a 50% chance to lose $100. The researchers told the first group that they had won the gamble, the second group that they had lost, and the third that they wouldn’t know the outcome of the game until later.
Knowing what we know about loss aversion, we might assume the group that was told they had lost might fold if offered the chance to play again. However, the experiment revealed quite a surprise. A majority of the winners and losers of the initial gamble agreed to play a second round of the game. However, the majority of those who didn’t know the outcome of the first gamble chose not to play.
These results clearly illustrate how uncomfortable we are with uncertainty. We like to know the score.
4. Consider that what clients worry about rarely happens. Lately, the media has been spreading the idea that rising interest rates will blow up portfolios. Yes, as rates rise, the price of existing bonds decline. A rule of thumb is that for every 1% change in interest rates, a bond gains or loses 1% in value for every year of duration. So a 1% increase in market interest rates would cause a bond with a duration of five years to fall in value by 5%. That’s hardly a blowup, and certainly not a reason to flee the asset class.
Just as Janet Yellen, the chairwoman of the Fed, believes a gradual path is prudent and gives the Fed flexibility, we are taking a similarly measured approach with our portfolios, favoring bonds with shorter maturities that are less affected by interest rate changes. But we’re also stressing to clients that in all markets, bonds remain a core component of a properly diversified portfolio, one that delivers income while moderating overall risk.
We are mindful, too, that rising rates can create opportunities. Over time, bond funds should generate more income, and if you invest over a long period, this added income can help offset price losses. Also, as prices go down, some bonds may become undervalued, and individual investors might be able to buy securities that offer higher yields.
5. Focus your attention where it’s most needed. You might be inclined to target your younger or newest clients with your outreach. In reality, clients a decade or so away from retirement are probably the most vulnerable to stress from market swings. After all, they have less time to make up any losses before they retire and begin taking distributions from their portfolios. The fear of additional losses may cause them to question their long-term investment goals, and they may want to reduce their retirement account contributions at the very time that the IRS catch-up provision allows them to contribute more.
Above all, be honest when addressing volatility. That means admitting that we don’t know what will happen next. We advise clients to stick with a diversified plan and not to view market swings through a daily, weekly or even a quarterly lens. Focusing on the news headlines always comes at the expense of personal goals.
As with any relationship, consistency is a comfort in times of stress, and our investment approach has not changed as a result of increased market volatility. We make changes to our clients’ portfolios when their goals, time horizons or risk-tolerance change, not because the markets fluctuate.
But it also helps to keep the wisdom of the Traveling Wilburys in mind. No matter what happens with the markets, your clients need to know that they’ve “got somebody to lean on.”
Kimberly Foss, CFP, CPWA, is a Financial Planning columnist and the founder and president of Empyrion Wealth Management in Roseville, Calif., and New York. Follow her on Twitter at @KimberlyFossCFP.
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