Helping Your Clients Cope with Volatility
The biggest responsibility as an advisor is to protect clients from themselves.
Helping Your Clients Cope with Volatility by Tina Orem
Overall market trends appear to be up for some investments, but they’ve come with a substantial, nerve-rattling price tag: volatility.
The VIX—a sentiment indicator based on prices of puts and calls for the S&P 500—is the most common measure of the market’s expectations for near-term volatility. Though it’s come back to earth since 2011, when it was well over 40, the VIX is still a moving target in 2015, ranging from about 12 to a brief spike that took it over 50 in late August. That’s steep considering that over the long term, the VIX typically hovers in the high teens.
For investors, it’s like riding the world’s longest roller coaster. And after surviving the stomach emptying barrel rolls of the last recession, it’s no wonder many of them are still queasy about volatility.
Coping with volatility
As a financial advisor, here are a few strategies you can use to help calm your clients’ nerves, no matter the twists and turns of the market.
•Don’t assume only older clients care about volatility. Sure, they’re the closest to retirement, and their portfolios don’t have much time to recoup after corrections. But even clients with time on their side may not be able to stomach volatility the way they used to, and you will have to work harder to win them over. “The ones that I see that seem to be most freaked out about this are the Generation Xers,” says Curtis Cloke, CLTC, LUTCF, president of Acuity Financial in Burlington, Iowa. “I just had somebody come in to me today, 41 years of age. He’s been Your biggest responsibility as an advisor is to protect clients from themselves. a machinist for a number of years; he’s now a part-time professor. I was shocked. He’s developed a savings of about $200,000, and every bit of that $200,000 is sitting in a savings account, a CD less than two years, and a money market account with a 50 b.p. guaranteed rate.”
Cloke, a member of NAIFA-Southeast Iowa whose firm has about $100 million under management, says he asked the client why he wasn’t investing in the market. “His answer was, ‘Can’t tolerate the losses that I saw [during the recession].’”
•Understand that volatility on paper and volatility in real life are two different things. Studying a roller coaster’s twists and turns from the parking lot feels different from actually riding it. That is why you need to look beyond risk tolerance questionnaires and figure out what makes your clients panic in the real world.
“When I’m in the comfort of your office and everything seems to be comfortable, I will tell you that I don’t mind if I opened up my 401(k) statement and saw a 20 percent decline,” explains Tim Kiesling, CLU, ChFC, RICP, CRPC, NAIFA-Wisconsin member, and president of Kiesling Financial in Menomonee Falls, Wisc. “Then reality happens, and I open up that statement. And I see that it was a 10 percent drop and I want out.”
Time and experience have taught him that there are some common panic triggers. “Most people first start to kind of twitch, if you will, at about 10 percent [drops in portfolio value]. At about 20 percent, the panic is setting in,” he says. He has also learned that triple-digit drops in the market in a single day also make clients nervous and make them more likely to pick up the phone. The press also tends to spook people, says Kelly Kidwell, CFP, CSPG, NAIFA-California member, and president of Pacific Advisors in Claremont, Calif. “If there’s a 6,000-point drop again and it goes one point further than the last one, they’ll say, ‘It’s never fallen this far before!’ Of course last time it fell from the lowest spot, which is actually more significant,” he says.
• Create some guaranteed income for the client. Clients investing for retirement can mitigate the volatility fear factor by allocating some of their portfolios to annuities, says Dick Weber, CLU, AEP, and president of The Ethical Edge in Pleasant Hill, Calif. “That’s a form of diversification with an asset that you normally wouldn’t think about,” he says. “The biggest fear people have is outliving their money. We want to have some diversified components of lifetime income.” Kidwell, whose firm has about $2 billion under management, says he likes fixed annuities and cash-value life insurance products, especially from dividend-bearing mutual companies, for the fixed side of portfolios. “I’m pretty comfortable after that following the client’s lead on asset allocation beyond the guaranteed products,” he says. The 3.8 percent to 4.2 percent IRRs Cloke says he’s seeing on deferred income annuities are also comparable to market returns, he notes. The S&P returned just over 11 percent over the last 30 years, he says, but after factoring in fee drag, taxes and inflation, that shrinks to an elusive 5.97 percent.
• Remember why you’re an advisor. Many advisors second-guess themselves in volatile markets, especially those whose stay-the-course mantras were tested during the last recession. “At some point as an advisor, there’s a little bit of self-doubt that’s saying, ‘You know what? Maybe I should just do something,’” Kiesling says. “Because odds are, if you’re continuing to call me as my client and I’m saying, ‘Stay the course, stay the course, stay the course,’ you could very easily call any other advisor and that other advisor’s going to say, ‘If we just make a little change here, I think we’re going to be OK.’ Your natural inclination is to go to the person who can do something for you.”
If the market or tax laws have materially changed, reviewing portfolio strategies is warranted, he says. But your biggest responsibility as an advisor, particularly during high-volatility periods, is to protect clients from themselves, he says. This usually involves doing a series of calm affirmations with panicking clients by asking them whether their age, expected retirement age, health or spending habits have changed. “If they say no, everything’s pretty consistent, it’s all pretty much the same, I say, ‘OK, well, remember these dollars that we had positioned? This is part of your portfolio that we had designed and earmarked for your retirement, which we just agreed is going to be 20 to 25 years down the road,” he said. “We knew we were going to face some of this because that’s the only way we can participate in the potentially higher returns that the market offers. If we didn’t want to do that, we would have allocated into different products for you, but you just offered to me that nothing has changed; so, I want to make sure that we’re not making an emotional decision as opposed to a tactical one.”
• Write new rules. Perhaps the most important coping mechanism for volatility is to recognize that investing is very different from what it was before the recession. You need to get your clients used to more volatility. Furthermore, expected higher taxes, persistent low interest rates and faster trading technology, which makes the market less efficient due to information advantages, are ensuring that the market’s historical average returns won’t be its future average returns, Cloke says.
“When I’m working with clients who are building long-term assets primarily as a source of retirement income, I try to discourage them from looking at the day-to-day volatility, because that will drive you crazy,” Weber says. “Emotionally, I don’t like the roller coaster; intellectually, I know I have to stay on it,” Weber says.
Tina Orem is a frequent contributor to Advisor Today.
This article appeared in Advisor Today.