How’s your adviser doing?
Uncertain times like these offer them the opportunity to shine
If you invest through a full-service financial adviser, the COVID-19 crisis has tested your adviser’s ability to help you manage your investments in a smart way.
If they are doing a great job, this is their chance to shine and demonstrate tremendous value. But just as tellingly, the crisis can also reveal their shortcomings.
Here’s a thumbnail sketch on what you should expect your adviser to be doing and — and just as importantly — not doing.
Like other tests, a successful outcome starts with proper preparation. A portfolio that was well-designed in the first place should help you withstand the stock market meltdown while still allowing you to achieve a reasonable set of long-term objectives.
If that’s the case for you, your adviser should now be helping you “stay the course,” which involves avoiding the temptation to sell off equities at beaten down prices. You shouldn’t have to do much to change up your portfolio, apart from at some point starting to rebalance.
Your adviser’s most meaningful role in a crisis is usually in providing communication, guidance and support, rather than doing much in the way of buying and selling investments.
“The adviser should be creating psychological time and space to absorb, understand and process,” says Stephen Horan, managing director for the Americas for the CFA Institute, a global organization of investment professionals.
During market downturns, it’s easy to get caught up in the prevailing sentiment of anxiety, and sometimes outright panic, but the good adviser counteracts that with an informed, calming presence to focus your attention on doing the right things.
“This is where advisers can really add value because the adviser’s investment philosophy can be this ‘centre of gravity,’ ” says Horan, who is also co-author of “The New Wealth Management,” a guide for financial advisers.
The investment process should have started with your adviser thoroughly understanding your needs and circumstances, then helping you build the right portfolio to match it.
If you are investing for long-term goals such as a comfortable retirement, that generally means creating a balanced portfolio consisting of stocks and relatively safe fixed income in a proportion that reflects your risk
tolerance and other individual factors.
While the right combination will vary by individual circumstance, you generally need a sizable proportion in equities to drive most of your longterm returns, but also a chunk in relatively safe fixed income (like investment grade bonds and government-insured GICs) that doesn’t earn much income these days but helps cushion your portfolio during a big stock downturn.
Periodic stock downturns are a fact of life, and every investor and adviser needs to be prepared for them to happen with little or no warning.
When stock downturns do happen, no one can reliably predict the path to recovery. The most you can count on is that the recovery can be expected to occur in an unpredictable pattern over what could be months or years.
That uncertainty means that the best approach to long-term investment success is usually to set a long-term asset allocation and largely stick to it through the ups and downs in the market — hence the “stay the course” approach that also entails a “buy and hold” approach to investing.
It’s tempting to want to bail out of stocks during market sell-offs, but selling at low points turns paper losses that are generally temporary in nature into realized losses that are permanent.
Whether your adviser’s message is credible now depends on the expectations they developed over your relationship. If your adviser helped you clearly envision the risks and opportunities from the start, the message now should be a timely reminder rather than novel insight. “Ideally these communications are made on a foundation that has already been built,” says Horan.
In my view, your adviser’s message now should sound something like this: “Remember when we set up your investment plan, I told you that a market downturn like this was likely to happen at some point with little or no advance warning? Remember also the investment plan that we created was designed to weather a storm like this provided you stuck with the plan?”
The good adviser should shake up complacency in good times, but calm fears in bad times. There may be legitimate reasons to revisit your asset allocation if you have a major change in circumstance, such as if you’ve been thrown out of work.
Even then, a well-designed portfolio can help you weather that situation by providing a reasonable amount of cash and other relatively safe investments that can be accessed easily to help you bridge the period until you find another job. “People don’t think about a ‘safety reserve’ as investment management, but it really is,” says Horan.
If you’re a retiree, your adviser can help you structure your portfolio to generate fairly reliable cash flow without the need to sell equities when stock prices are depressed.
While many investors find it difficult enough to stay the course with a buy and hold approach, the good adviser can help you perform even better by rebalancing. That, however, is at “the next psychological level,” says Horan. “It just requires a lot of intestinal fortitude.”
The general concept behind rebalancing is that at some point, when stocks have been reduced in value, you should sell investments that have largely maintained their value (like investment grade bonds or cashable GICs) to buy stocks at lowered prices. To explain why, Horan cites the Warren Buffett quip that “I like to go shopping when things are on sale.” But that’s tough to do psychologically because it means acting precisely contrary to the prevailing emotional state that most other people are exhibiting.
Rebalancing is designed to get your asset allocation back to its target after it’s been thrown out of whack by the stock downturn. So if your target asset allocation is 60 per cent stocks and 40 per cent investment grade bonds, and stocks have declined by 20 per cent while your investment grade bonds are unchanged in value, the resulting asset allocation for now would be 55 per cent stocks and 45 per cent bonds. To rebalance, you would sell bonds and buy stocks until the asset allocation again reached 60 per cent stocks/40 per cent bonds.
There is no one right way to rebalance. Some experts prefer to do it quickly, but it is probably more common to do it gradually. It requires judgment and, with so much uncertainty, no one rebalances perfectly to catch the market bottom except through blind luck.
Although rebalancing isn’t easy, it helps achieve superior investment performance in the long run, as Horan points out. “Studies show that rebalancing strategically outperforms ‘buy and hold,’ but ‘buy and hold’ does outperform reactive trading.”
Horan also described some “red flags” that may indicate your adviser isn’t providing the quality of advice you should expect.
The first is someone with “an inflated sense of confidence” who leads you to believe they can reliably predict what the market is going to do in the near term. The second is the adviser who wants to make wholesale changes to your portfolio, which could indicate they didn’t set it up right in the first place. The third is the adviser who exerts pressure, saying something like “Markets are moving fast, we’ve really got to make a decision now.”