I wish every client could be like the real estate executive I handle in Philadelphia. When I signed him up in the summer of 2000, most of his net worth was tied up in properties. So, I was hired to diversify it by creating a 100 percent equity account. As 2001 drew to a close, the value of his holdings had shrunk by about 25 percent.
Needless to say, I was not looking forward to our year-end client meeting. But I was prepared. I was sure that, despite the shellacking his portfolio had taken, I had earned my fee — a percent of assets under management. Heck, my income was going down, too!
As I was walking down the hall to his office, he saw me coming and threw up his hands in despair. “Just realize my losses, all of them that you can take, and come back and see me in January,” he said. “I don't want to talk about it now. It's too painful.” He turned around and walked away.
It could have been worse. He could have said, as another client did: “Why should I pay you to lose me money?” This question is being tossed at brokers everywhere by investors who, when confronted with their brokerage statements, suddenly forget their long-term goals. Many are looking for a scapegoat.
Here's how to prepare for these inevitable tough moments:
Have clients sign an investment policy statement.
Most advisors do this, but if you don't, start. This goes beyond the required suitability questionnaire your firm requires. It is the basis for all financial planning. It determines how you allocate assets and codifies objectives and time horizons. Your client signs it, and you sign it. If your client understands what he has signed, he is less likely to blame you (entirely) for portfolio losses.
Remind your client about the futility of market timing.
In the five years ended in December 2000, the market gained an average of 18.3 percent annually. If you missed the 30 best market days during that five-year period, your return averaged a negative 2.1 percent. That's right: You would have lost money if you were out of the stock market for just those sessions. You have to be in it to win it.
But you can adapt to the market cycle — a little
Obviously, you should keep your long-term perspective. But your diversification within asset classes can be marginally tailored to fit the economic cycle. I follow the Federal Reserve's model for stock market valuation, called the earnings yield model. Basically, the Fed compares the yield on common stocks (based on anticipated earnings) with that of 10-year Treasury bonds. When the earnings yield of the Standard & Poor's 500 is much lower than that of the Treasurys, it is often an indication that the market is overvalued. (For more, see www.yardeni.com.) When this metric shows overvalue by say, 15 percent or more, you might shift to a more defensive posture.
Review history and long-term goals.
Show your client what a 100 percent stock portfolio has returned. Then show him what an 80 percent stock/20 percent bond portfolio has returned, and so on. And then remind him of his goals. Remind your client, too, that if he is down 20 percent, it will take a 25 percent rebound to get him back to even. It would take roughly five years to accomplish that in bonds and between seven and 10 years in money markets or CDs. Review his goals and objectives with him and make sure nothing has changed. Then, if necessary, make your client an offer. Offer to forego your fees for one quarter. You may be surprised at the result. I was. My clients usually decline my offer.
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Principal at the Wharton Business Group