A client’s resolve

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I’ve talked about how a financial plan brings clarity to a client’s current situation and allows you to plot a course for the future.

The planning experience gives the client more confidence and a new resolve that is hard to shake. But I never said the client’s new resolve “can never be shaken”.

As helpful as a financial plan can be, it doesn’t insulate the client from overreacting to the volatility the markets can create. This is especially true of growth oriented clients that were invested in stocks over the past 10 years.

The engine

Remember, often a financial plan is powered by the underlying market investments. In order for a client to get closer to their goals, we need for that portfolio of investments to perform. If a client is lucky enough to have learned (via their financial plan) that they only need a 5% return on their investment assets, to achieve their goals, then we have little to worry about.

This type of allocation would be a pleasure to design and will hardly generate the type of emotions that may test a client’s resolve. Unfortunately, most people are not in that boat.

Most people need better than 5% returns and, consequently, need to take on more risk to achieve their goals. For the purposes of our discussion, risk and market volatility are synonymous; and when there is market volatility there are strong client emotions.

Historical market returns

Lets take a look at the historical relationship (from 1926 through 2000) between market returns and market volatility:

• A portfolio made up of 100% equities (stocks) returned an average of 11% a year. With the best year being +54% and the worst year being -43%. Over any 5 year period, the volatility is greatly reduced, with the best five years being +29% and the worst five year period being - 12%.
• Using the same time-frame, a portfolio of 65% equities, 30% fixed income (bonds), 5% cash returned an average of 9.6% a year. With the best year being +40% and the worst year being -30%. Over any 5 year period, the best five years returned +21% and the worst five year period returned -6%.

You can model client scenarios until you’re blue in the face but if the investments under-perform the plan assumptions then you’re moving in the wrong direction. If you move in the wrong direction for any significant amount of time… the client’s resolve “can be shaken.”

If the client’s resolve is tested over and over, their emotions can get the better of them and they may end up making poor decisions. For example, selling out of the equity portion of their portfolio close to a market bottom.

Over the long term

Thankfully, from my experience, over any extended period of time, with the help of solid diversification and account re-balancing, this kind of client behavior is the exception to the rule; but you must be vigilant. That’s why it’s very important to:

• make sure client expectations are realistic
• make sure the financial plan investment assumptions air on the conservative side
• keep an open line of communication to reassure clients about staying focused on the long term outlook

In the end human behavior is unpredictable; a financial plan can help steel a client’s resolve and bring a modicum of predictability…

Tags: Featured, Historical Market Returns, Psychology Behind Financial Planning, solid diversification