When the market is going up investors don’t think they need investment advisors; when the market is going down they often think they need to change investment advisors. This apparent contradiction is usually the result of poor communication. Nothing causes investors to question their investment strategy more than dramatic market moves. So in the absence of guidance clients often make emotional decisions.
Volatility has returned to the market. Stoked by concerns that global growth is slowing, which was prompted by a collapse in the Chinese stock market and China’s decision to devalue its currency, the market has recently experienced some wide swings. Add to that declining oil prices and expectations of a Federal Reserve rate hike, uncertainty is rampant.
For some investors, the natural reaction to this uncertainty is to reduce or eliminate exposure to equities. Their gut says moving to cash is the best choice, but that decision may not make sense in the long run. And if they looked at the statistics, they’d realize they might be better off waiting – at least a few weeks anyway. The challenge they face is that when they rely on their emotions to make investment decisions investors usually make the wrong moves. They get out at the bottom because fear pushed them; then they get in at the top because greed pulled them. What does this mean? It means emotions aren’t effective investment managers.
What is appropriate? Employ a disciplined, quantified process and make sure the plan meets their expectations. Call your clients and discuss the following:
- Assess their situation: Remind them that markets go up and go down and that this volatility is likely to continue for a while. Reassure them that they have a manager watching their accounts and making adjustments to try to minimize the risk.
- Reevaluate their expectations: Ensure that they have the appropriate plan in place by reviewing their time horizon, goals, and tolerance for risk. By confirming that their circumstances haven’t changed, you bolster their commitment to remaining invested.
- Make sure they are comfortable with their investments: If they lose sleep when their account value goes down, they may need to reduce their risk profile. Even if they have suggested they are growth investors with a long-term time horizon, sometimes a moderate portfolio is appropriate. If watching balances fluctuate keeps them awake, reallocate until they can sleep. Consider adding some of our income based strategies as a component of their overall mix.
- Diversify: One of the most important things you can do to help manage the risk of volatile markets is to diversify. At Q3 we are firm believers in the power of diversification to reduce risk. But we think traditional diversification is limiting. Traditional diversification is the concept of holding multiple asset classes. The trouble with this traditional approach is that when the market corrects all equities become correlated so everything goes down. We advocate Strategic Diversification. Strategic Diversification is the idea that combining different management approaches is the best way to reduce risk. Since no management approach works in all markets, combining different management approaches provides a greater opportunity to minimize portfolio risk.
The bottom line… Encourage your clients to focus on the plan, rather than focusing on the turbulence. Remind them that the plan we have is designed to help them ride out the peaks and valleys of the market, and help them achieve their financial goals.
As always, if there’s anything we can do to help don’t hesitate to call.
Q3 Asset Management