“History doesn’t repeat itself, but it often rhymes.”
—Mark Twain
In 2009, Horsesmouth published a white paper that reflected on the lessons advisors learned from the crash of 2008. It contained many great insights from a number of advisors, almost all of which still make sense today, 10 years later. As another recession is expected to arrive around late 2019-2020 according to the cover of last week’s Barron’s, it may make sense to prepare ourselves once again for the inevitable.
Lesson 1: Own the responsibility and be vigilant!
The 2008 bear market taught investors that, first and foremost, it’s important to take responsibility for the location of your clients’ funds, and to understand that, in such a tumultuous time, you can only really trust yourself. While it can be helpful to have the advice of economists, strategists, and analysts, you shouldn’t rely on these other people to the extent that you, the advisor, exert no real control over your clients’ funds.
In addition, you can’t outsource your funds to people like money managers and expect the same care and attention to be taken had you done the work yourself. These outside managers have disincentives to raise cash, even if the circumstances show that a defensive move is right. They also tend to have less flexible investment styles, which hurts the client, especially in bear markets. And remember, in a bear market, cash is king!
Also, remember to conduct your own due diligence. As shown in 2008, when S&P and Moody’s promised that there was no issue with the subprime mortgages (up until the market totally crashed), sometimes third parties just can’t be trusted, no matter how legitimate they may seem. While rules and regulations have certainly improved since then, it’s important that advisors not blindly trust recommended investments, especially when the recommendation is coming from a biased source. As an advisor, you represent your client’s needs first and foremost. Trust your years of experience and remember that.
Getting prepared
- Do you have a rainy day fund in every client portfolio?
- Does your client have sources of liquidity?
- Do your clients have access to cash in the event of a downturn?
- Do you understand everything you own and how it would perform in a bear market?
- Are the managers in your portfolio sensitive to risk?
Lesson 2: Clients prefer absolute return in market downturn
Clients never want to incur heavy losses! Although some advisors see the occasional heavy loss as the price of long-term investing, that is not the typical client’s view. Clients would rather end up in the green (or be slightly negative) than have a massive loss. In addition, advisors need to have more conversations with clients about acceptable amounts of loss, and frame it in terms of percentage of assets at risk and actual dollar amounts. As we learned in 2008, clients can be very unhappy despite beating market benchmarks if they’re still losing lots of money. Consider giving clients the returns they need on a consistent basis, particularly when we are nearing the end of the economic expansion and a bear market could be coming up.
It has been almost 10 years since we have experienced a negative year, and clients are used to spending how they like. It is in times like these that you must help clients stay on budget. In a low- or negative-return market, clients will often still want to deplete their principal through unchecked spending at the same rates they had in a positive-return market. This can lead to higher withdrawal rates and negative tax repercussions. Try to temper clients’ expectations (a bull market doesn’t go on forever) and prepare them for the upcoming bear market, so that they can adjust their lifestyles and expenditures accordingly.
Getting prepared
- Do you review your clients’ spending on a regular basis?
- Are you familiar with the needs and wants of your clients?
- Have you created a financial plan for your client that takes a bear market into account?
Lesson 3: Take defensive measures
The cataclysm of 2008 taught investors that preventive measures can be worth their weight in gold in times of market chaos. Although once scorned, moving clients to large cash positions (or short-term bonds) is often safer than risking a large portfolio loss, considering the time it takes to build back a portfolio. A sell strategy is also important to develop, as a slight loss is far better than a catastrophic one. A sell strategy also goes hand in hand with investment discipline, which, although it may be more boring, protects both clients and advisors from suffering larger losses in the long term.
Diversifying portfolios more broadly is another strategy that, if used in 2008, would have helped to protect more clients from dramatic losses, as the standard “diversified” portfolio at the time failed to protect client assets. Overall, defensive measures are vital to ensuring that portfolios can’t and won’t go into such drastic freefall like they did in 2008 ever again.
Getting prepared
- Do you have a hedge in your portfolios?
- Are your portfolios widely diversified?
- What is your sell strategy?
Lesson 4: Get your own house in order
Although advisors are typically focused on clients’ finances—and rightly so—this focus should not come at the cost of an advisor’s personal finances. In 2008, fee and commission revenues decreased, forcing advisors to take a closer look at their operations, efficiencies, and their own personal cash flows and retirement plans. By reviewing the budget for your business and cutting unnecessary expenses, you can save more each year than you think. Also, consider starting an emergency fund, just as clients are encouraged to do.
Getting prepared
- Do you have a liquidity fund?
- Are you positioned to handle a bear market?
- Is your income stream diversified?
- Have you recently reviewed your expenses?
- Are you operating as efficiently as possible?
Lesson 5: Be open to change
Don’t assume that what has worked in the past will always work in the future. Advisors should make sure to constantly reevaluate their approaches, try new strategies with clients, and revisit current plans, even those that have been around for years. A risk-tolerance questionnaire can be an important tool to learn what, exactly, a client will endure in the market. Many of us have also learned that waiting out storms is no longer to be expected, as clients will leave advisors, despite a strong personal relationship, if heavy losses are incurred. Advisors need to be nimble in changing markets in order to get the best returns for their clients, and that may mean not waiting out storms—or it could mean considering an underutilized strategy because it now makes sense.
Getting prepared
- Do you review risk-tolerance questionnaires with your clients at every meeting?
- Is the client’s portfolio protected against a bear market?
- Are you considering additional strategies?
Lesson 6: Keep communicating with clients
Even when clients are taking losses, it’s vital to call them up, despite how difficult it may be. Open communication between advisors and clients is never more important than when a client is dissatisfied and, although it’s much easier to make the call when a client is up 20% rather than down 40%, the call must be made.
Studies also show that dissatisfied clients won’t call their advisors: they’re much more likely to just bad-mouth them to everyone they know. In addition, when you keep communication open between client and advisor, clients will often take losses better. That is becauase they have more realistic expectations and a higher level of education about the state of the market than clients who are kept in the dark. Inaction harms relationships and decreases client retention.
Reaching out and scheduling regular meetings also differentiates advisors. It shows clients that you are keeping the clients’ best interests at heart. Also, consider asking clients themselves how you can do a better job, as opposed to just assuming. Listening to client feedback is important, and helps both parties feel more satisfied with any agreements you make. By regularly reaching out to clients, especially in times of market stress, your relationship and trust will improve and more clients will stick with you than if you are inactive.
Getting prepared
- Do you have regular meetings/check-ins with clients regardless of the market?
- Do you seek feedback from clients?
- Is there a Client Advisory Board in place?
As you can see, a bear market can be an opportunity to solidify your relationships with your clients, if you handle the situation in a proactive and thoughtful way. After all, this is what a good financial advisor is here for.