The financial planner in times of trouble ...

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The financial planning process is complex and includes many areas: advising on matters of cash flow today and in the future, risk management, retirement planning, income tax planning, investment planning, estate planning, business succession, family governance, and just about any financial issue that comes up in the lives of your clients. Notice that investment planning is just one of those critical components of a financial planning relationship (albeit a very important one).

The marketplace of financial advisors (note that I didn’t use the term “financial planner”) over the years has shaped the consumers’ view of what constitutes a good relationship with them. In short, most people think that financial planning is all about investing. The financial community, of course, is OK with that, as most revenues are generated from asset management or oversight. Ignoring the remaining items that would reasonably be included in a financial planning engagement saves the advisor a lot of time — except during times of high market volatility.

The single-dimensional relationship underpinned by investments puts the spotlight on you during times of market volatility. Especially if you try to sound like some big-shot analyst who believes their own forecasts. The reality, however, is that neither you nor anyone else who calls themselves an investment professional knows the date when markets will dip and the date when markets will start to rise again. Markets go up and down, as do most portfolios.

I believe that the planner’s role with respect to market volatility is to have open discussions about volatility when you engage with a client. If your client has a high risk tolerance, and wants their investments to match the performance that they hear about in the news, then you better explain markets and volatility to them.

I like to see volatility explained in terms of the range of expectations for any investment. Of course, the compliance people would be very unhappy with me if I didn’t remind you that past performance is no guarantee of future results — but you already knew that. But an education for clients about the past range of performance for the markets or the specific portfolio that you may recommend can be helpful to all.

Do the math, and more

There are two ways to find out what is the optimum portfolio for your client. One is to mathematically calculate what they need to earn in order to meet their life’s objectives. The other is to discover their tolerance for risk, and learn just how much volatility they can take.

The mathematical take sounds very intuitive and logical until you get into the details. In order to calculate the rate of return required by your client, a formula that includes many variables must be deployed. Many of these variables are out of your control: Inflation, tax rate, and portfolio results are just a few. While today you may all agree on the reasonableness of the assumptions used, we all know that they will not be 100 percent accurate and that the forecasts will need to be reassessed for the shifts that will occur within the variables. A good financial planner will reconcile each year the forecasts delivered in the prior year to the realities of the current day, and then adjust accordingly.

The second method is to use a risk tolerance questionnaire. This may feel a little superficial, but as each day passes there are technology tools being introduced that try to make this estimate of just how much risk your clients can tolerate into a quantifiable answer. Nothing in the RTQ space is foolproof, so find one that works for your firm and use it with every client.

With a little luck, you’ll find that your client’s quantitative take is not too far to the left or right of the risk assessment tool that you are using. If there is discord, it can’t be ignored. If your client needs to earn a relatively high amount but has absolutely no tolerance for risk, you must speak up. It’s the planner’s job to come up with alternative solutions, as painful as they may be. Some of these solutions may be to spend less, downsize the home, earn more, or delay retirement. None of these solutions are good news, but it is better that your clients find out about their core issues sooner than later.

In each client review, I think it’s good practice to bring the humility and reality that markets may behave irrationally, and there isn’t much that any individual can do about that except to turn off all risk and take cover. If you do that, good luck trying to decide when and how to get back in. We’ve all seen the data in terms of poor investor returns if you miss the few biggest rally days in any given period. You’ll also notice that the best periods for market-driven returns are typically just after the worst one.

Another way that you may talk to your clients about volatility is to stress test their financial plan. You can run “what-if” scenarios regarding the variables not going in their favor. You may test for a higher-inflation scenario, portfolio losses, or higher spending.

During times of volatility, you may end up revisiting many of these same tools that you used at the start of your planning relationship to see if anything has altered. In prior years and market corrections, we’ve retested some clients’ risk tolerance. For the most part there weren’t material changes in their tolerance for risk.

What you can do

Your most important role during turbulent times is to be there for your clients. Make proactive phone calls to let them know that you are watching and thinking about them. Hiding or ignoring headline news about losses is not advisable.

You may end up revisiting the portfolio as a whole in terms of how it was constructed based on their needs and tolerance for risk. Show them some of the risk statistics and the consequences of the current market conditions on their financial situation.

Remind your clients that this is one of the few elements in their financial plan that is out of their control. This could be a good time to take a look at some of the Callan charts that show the sector leaders and laggards in year-by-year format. This underscores the unpredictability of investing and helps your clients to understand why diversification may be helpful in any given year. Of course, diversification is also no guarantee against losses or of better performance.

For the most part, the financial planner who has been practicing proactive and holistic financial planning is probably not receiving a lot of client calls when markets get volatile. Their clients understand and have learned to appreciate their planner because of all the other good things that the planning team has done for the family. That doesn’t give you a pass for lousy investment performance, but it sure takes the pressure off when they know that you’ve got their best interests at the top of your list.

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