Helping Clients Understand the Normalcy of Market Corrections
As a financial advisor, you work closely with your clients to craft investment strategies tailored to their objectives and risk profiles, and then monitor them over time. That very well may be the easy part of your client relationship. The more significant challenge you have as an advisor is to make sure your clients stay the course with their strategy even in the midst of a steep market correction.
One of the primary responsibilities of a financial advisor is to convey to their clients that the only concern they should have about a market downturn is not how deep it falls or how long it lasts, but how they react to it. After all, no one can predict when a market correction will occur, but we know that it will. After the longest bull market in history, clients tend to forget that stock prices can go down as well as up, and that market corrections are quite normal. That confers upon advisors the responsibility of educating their clients on the inevitability of market corrections and how they should react to them.
First, put market corrections into a historical perspective.
With the stock market, the past is prolog. So it helps to put market corrections in a historical perspective. The fact is that market corrections occur with some regularity. Since 2000, the market has experienced a decline of at least 10% (the definition of a market correction) in 11 out of 20 years. Their average decline was about 15%, and their average duration was four months. During that period, the S&P 500 has risen, on average, more than 8% one month after a market bottom, and more than 24% a year later.
The highly instructive takeaway is that market declines have been nothing more than a temporary suspension of a longer-term market advance. Market volatility is an essential phenomenon that drives stock prices higher. History has shown that the market rewards investors who can tolerate stock market volatility because they tend to avoid the costly behavioral traps of selling into market downturns or trying to time the market.
Then, explain to clients that if they don’t sell, it isn’t a loss.
Investors who react with fear by selling their equities after the market has already declined by 10 or 15% will invariably lose money. Many investors succumb to their “loss aversion” instincts hoping they won’t lose more money by selling. Clients have to be reminded that the only way they can actually lose money is when they sell after stock prices decline. Up to that point, their loss is only on paper. In essence, market risk – the risk of loss during market declines – is human-induced. The real risk to investors is not being in the next market decline; it’s being out of the market when it goes on to new highs.
And finally, keep clients focused on what is knowable.
No one can accurately predict the direction of the stock market at any given time, nor can anyone know when the next market-disrupting macro-event will occur. Warren Buffet once said, “I don’t think about the macro stuff… just what’s important and knowable. If it’s unimportant or unknowable, you forget about it.” For your clients, the only thing that is knowable and important is their long-term financial objectives and where they are in relation to them.
With a long-term strategy, it makes no sense to be concerned over short-term market fluctuations that, while seemingly consequential at the moment, will have zero impact on the long-term performance of their investments. Even significant market crashes of 40% will appear as a minor blip on their investment performance over 20 years.
Remember what clients need from their Financial Advisor.
Market corrections can be scary, especially if your clients aren’t prepared for them. But educating them on the role market corrections play in the long-term stock market advance, can alleviate their fears. When one does occur, you can remind them of their temporary nature and why it can help their long-term investment performance to stay the course. You can then use current market data to help your clients rationally reflect on their investment strategy and discuss any adjustments needed to ensure they are still on track.
Frequent communications are the key to a trusted client-advisor relationship but focus should not be on current market performance. Clients will value you more for helping them see how their strategy is working towards achieving their most important goals.
Your real value to clients is your ability to educate them in the laws of investing and keep them focused on their target. If their investment strategy is sound, it’s your job to hold them accountable for their decisions and prevent them from making costly behavioral mistakes. That’s why they pay you a fee – not for an investment strategy, but for the coaching they need to succeed.
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