Even the most brilliantly crafted investment plan has to be given time to work.
We know from behavioral finance that many people give up on a brilliant investment philosophy too soon. They chase returns rather than rebalancing. And we know from studies on mutual fund flows that investors underperform the very mutual funds they are invested in because they buy funds after they have gone up and sell funds after they have gone down.
The markets are inherently volatile, but are also inherently profitable. The market spends most of its time down 10%-15% from some prior high. Investors unfamiliar with normal markets movements are often shocked and nervous. When you start investing in the markets you are very likely to see many highs and lows as the market gyrates before you see permanent gains. Preparing clients for their first experiences of watching these movements in real time is an important part of the advising role.
Dan Moisand had an excellent article in the June 2020 issue of the Journal of Financial Planning entitled, “Surviving a Bear Attack .” In the article, he writes:
The Power of Planning
When I see that someone made a bad financial decision, I can usually trace the problem back to a lack of a plan, a bad plan, abandoning a good plan, implementing a sound plan poorly, or failing to revise a plan as needed. Clients of good financial planners do not have these deficiencies. You cannot be a good planner unless you develop good plans, help clients stick to the plans, implement the plans efficiently, and revise the plans effectively when needed.
No decent planner would ever create a plan that didn’t account for frequent market drops over their client’s lifetime with several of those drops being severe, terrifying declines because that is what markets have always provided. An assumption of no large rapid declines, or the ability to predict and therefore avoid such declines, defies the weighty evidence of history. Simply put, volatility should be a given.
Good plans are flexible enough that they can adapt. Interest rates, stock prices, economic growth, inflation, the tax code, our families, our friends, our jobs, and our health will all change. We just don’t know how or when these changes will occur exactly. Good planning expects uncertainty and the need to adapt to changes sensibly rather than reacting to pending change out of emotion.
Moisand says that there are five reasons that planning fails:
- Lack of a plan
- A bad plan
- Abandoning a good plan
- Implementing a sound plan poorly
- Failing to revise a plan as needed
He also says that “no decent planner would ever create a plan that didn’t account for frequent market drops … with several of those drops being severe, terrifying declines because that is what the market has always provided.” In the same way that advisors should plan for these drops in their asset allocation designs, clients should assume that even a brilliant strategy will experience these types of declines.
We design our asset allocations using long-term historical data and a skeptical eye. We design our asset allocation so that staying the course has the best chance of weathering the storm. When a drop comes, our plan is to rebalance.
We often go over this with new clients in a downturn dress rehearsal. We try to test our clients’ resolve and put into their investment policy statements, “You have agreed not to pull out of the markets if the value drops precipitously.”
Maintaining this resolve requires both experience with the markets and a history of discipline in implementing such a strategy. Moisand explains:
But it isn’t easy. Once a good plan is in place, the most likely impediment to success typically is not the economy, the markets, or our politicians. It’s folks who do not do what they planned to do. That is often the client, but it can also be the planner. This is where financial planning moves beyond a technical endeavor and becomes a craft, a profession.
Staying the course is good advice but it doesn’t mean do nothing. I see many planners frozen like a deer in headlights. They say things like, “I’m not sure it’s the bottom so I’m not sure I should rebalance or loss harvest or Roth convert, etc.” (I hope no one reading this told their clients they would only rebalance at a bottom!) If you have a rebalancing policy, apply it. If not, get one. Policies exist to reduce the chances of making emotion-based decisions.
We trade in client accounts about twice a quarter. In this way, during the recent downturn, rebalancing was inevitable and randomly timed. When we had a Roth conversion recommendation ready, we did Roth conversions. For many clients, we were tax-loss harvesting.
This is the work we do constantly, but it is important not to flinch when a drop comes. We have sayings that encapsulate these best practices. For example, we often say, “It is always a good time to have a balanced portfolio” and “When in doubt, rebalance.” This part of our firm culture makes us well prepared for doing important work before, after, and throughout all kinds of wild market returns.
Client communication is also important. Moisand explains:
If you didn’t communicate what you would do in a bad market and didn’t repeat to clients those intended actions regularly before COVID-19, you have a challenge in demonstrating reliability because the client has no reference point.
If you did communicate and are now not doing what you said you would do, you risk destroying the trust you created. The more dramatic the shift in approach, the harder it will be for clients to accept. You better have an easily digestible rationale, defensible through evidence, for such a change.
Both saying what you will do and doing what you said you are going to do is an important first step toward the process of financial planning as a discipline.
This past downturn, we also strove to communicate regularly about the downturn through articles here on our website.
Our publication cycle is normally several weeks from first draft to publication. During that time, an article goes through editing, compliance, and image selection. The process is intended to eliminate typos and produce higher quality articles. Some articles are considered unworthy of publication even after several revisions.
Writing is hard work, but it is important work.
But during the 2020 COVID Bear Market, we prioritized our new articles in order to get information onto our website in a timely way. We announced tax revisions as quickly as possible. We pulled up relevant TBT (Throwback Thursday) articles. The articles “Markets are Down? Time to Rebalance!” and “Roth Conversions are More Valuable During Bear Markets” were published around the bottom of the market. The article “The Lower The Market Falls The More Important It Is To Stay Invested” was written and edited in the ten days between gathering the data through 3/20 and its publication on 3/30.
Using our website to communicate to clients helped us reassure our clients and readers that these were normal market movements even if the situation was unique and novel. We were told that this form of communication was both helpful and calming. Here is our publications mapped to this 2020 COVID Bear Market:
Using our publication cycle during this Bear Market was an important part of communicating to clients and reminding them what the plan was, why it was important, and how it was going to be implemented.
Photo by Janko Ferlič on Unsplash