In the best of times, advisers have to remind clients about the
worst of times
Big stock market gains can
often mean big headaches for financial advisers when it comes to explaining to clients why
their portfolio didn’t keep pace with the S&P 500 Index, which gained 30%
last year.
Aside from the obvious answer that most
clients are not 100% allocated to a single broad market equity index, savvy
financial advisers are using this time of year to reintroduce clients to the benefits and realities of
diversification and individual risk-tolerance levels.
“When markets have big years people always
want to know why they’re not 100% in the S&P, and the answer is if your
risk tolerance doesn’t correlate to the S&P using that as a benchmark is a
fool’s errand,” said Paul Schatz, president of Heritage Capital.
Mr. Schatz said no matter how well you try and
educate and prepare clients, big market gains will usually draw questions and
comparisons.
In most instances, his standard response is to
compare the S&P’s 38.5% drop in 2008 to the 16% drop of his main portfolio
strategy.
“If you want to assume the risk and reward of
the S&P, let’s not forget that twice in the past nine years it experienced
peak-to-trough declines of more than 50%,” he said, citing the 50% drop between
2000 and 2002, and the 58% drop between 2007 and 2009.
2000 and 2002, and the 58% drop between 2007 and 2009.
“Most of the time we don’t meet or beat the
S&P 500 Index simply because we don’t take on the volatility risk to make
that happen,” said Tim Holsworth, president of AHP Financial Services.
“It’s almost always about the level of
volatility the client said they could handle,” he added. “it’s all about
clearly defining volatility limits and setting
realistic expectations.”
realistic expectations.”
The risk-reward conversation is not a new one
for most financial
advisers, but that doesn’t mean they aren’t regularly revisiting it with
clients, particularly after a year like 2019 when diversification beyond anything but U.S. stocks dragged down portfolio performance.
advisers, but that doesn’t mean they aren’t regularly revisiting it with
clients, particularly after a year like 2019 when diversification beyond anything but U.S. stocks dragged down portfolio performance.
In the most basic example of a portfolio
including 60% in iShares
Core S&P 500 ETF (IVV) and 40% in iShares Core US Aggregate Bond ETF (AGG), the return would have been 22% last year.
Core S&P 500 ETF (IVV) and 40% in iShares Core US Aggregate Bond ETF (AGG), the return would have been 22% last year.
If you go beyond the plain vanilla to include
areas like international
equities the trailing performance gets even worse.
equities the trailing performance gets even worse.
“Investors would have been better off focusing
solely on U.S
stocks last year, but historically that’s not the case,” said Todd
Rosenbluth, director of mutual fund and ETF research at CFRA.
stocks last year, but historically that’s not the case,” said Todd
Rosenbluth, director of mutual fund and ETF research at CFRA.
“It’s easy in hindsight to wish you had only
been in equities, but the bull market will come to an end at some point and
investors will be pleased they are more diversified when that time comes,” he
added.
Factor-based strategies
Of course, if you really want to feel bad
about the way a diversified portfolio performed last year take a gander at some
of the factor-based strategies that
concentrate on specific slices on the high-performing S&P 500.
Indexed factor strategies focused on minimum
volatility, share buybacks, quality, and high beta all returned between 32.4%
and 34.4% last year.
But looking in the rearview mirror is
virtually useless when it comes to investing, according to Aye Soe, global head
of product management at S&P Dow Jones Indices.
“I’m not a believer in factor timing because
we never know what factor is going to outperform,” she said. “My message is,
even though you think you know what you will get, be diversified and have
exposure to all these factors because you don’t know which will do better.”
Dennis Nolte, vice president at Seacoast
Investment Services, is a firm believer that most investors think their
individual tolerance for market volatility is higher than it is, which is why
he embraces a simple adage.
“If your clients are properly diversified,
you’re always going to be apologizing for something,” he said. “But at this
point, no one seems to be concerned they didn’t make 30% last year. They’re
glad to have taken less risk and received less of a return, since most folks
still seem to believe something bad is going to happen.”
No comments:
Post a Comment