Having a long-term financial plan gives your clients' logic a leg up over their emotions during times of market volatility.The past year has seen the stock markets swinging hundreds of points a day in either direction. That roller coaster ride has tested even the most stoic of investors, but those with a professionally prepared, long-term financial plan most likely have fared better than most do-it-yourself investors.
The emerging science of neuroeconomics, which combines neuroscience with economics and psychology, has made amazing findings about the brain and investing-related emotions using imaging technology.
These studies have found that the survival wiring in your brain, which makes you desire reward and avoid risk or pain, has stronger grounding than your logical wiring. Put to the test, the desire to avoid pain - which always outweighs the desire for reward - will usually win over logic.
A financial plan can bolster logic when emotions want to take over. Its greatest strength lies right within its construction. Financial planners develop client plans based on their personal situation, including their goals, their age, their assets and income, their liabilities and their individual tolerance for risk. Faced with volatility and the emotional desire to flee the pain of market losses or increase the euphoria of market gains, the financial planner takes clients back to the plan.
Has anything changed in the client's personal situation as a result of the market's ups and downs? If not, there's no reason to change the plan.
That's not to say that financial plans should be created in a vacuum and then shoved in a drawer to be dusted off in 10, 20 or 30 years at retirement. The financial planner will review the plan with their client at least annually, and whenever they face a life-changing event, including the birth of a child, an empty nest, retirement, divorce or widowhood, or the illness or disability or death of a spouse, parent or child.
Multiple studies of past market data have shown that the longer money is invested in the market, the less volatility a portfolio experiences. That's because time allows the highest highs to offset the lowest lows. On average, the markets have had positive returns in seven out of 10 years for the past 70 years, according to the Financial Planning Association. The longer a client is invested in the market, the more up years they will accumulate.
Market swings make headlines simply because they reflect change - one of journalism's criteria for news-making. As we've seen this year, daily swings don't necessarily reflect a trend of any significance. The market can be up hundreds of points one day, only to be down the same amount the next day. Trying to guess which way it will go for a given day, week, month or even year is a fool's game that plays to the emotions.
Financial planning, on the other hand, plays to logic. As clients reach milestones in their lives, they can look at the plan and say, "Ah, yes. My planner talked about this, and we prepared for it." That applies to market volatility as well. The financial planner uses technical tools to take into consideration the affect of market volatility and uses diversification, asset allocation and rebalancing, among other strategies, to offset those risks.
Will client account balances at times show a drop in value?
No one can guarantee they will never lose money on an investment. A financial plan and the counsel of the financial planner, however, can give their logic the boost it needs to keep their emotions from running roughshod over their financial goals.
J. Graydon Coghlan is president and chief executive of Coghlan Financial Group Inc. Reach him at (800) 884-5121 or firstname.lastname@example.org.
Register or login for access to this item and much more
All Accounting Today content is archived after seven days.
Community members receive:
- All recent and archived articles
- Conference offers and updates
- A full menu of enewsletter options
- Web seminars, white papers, ebooks
Already have an account? Log In
Don't have an account? Register for Free Unlimited Access