We all know the basics of investing: diversification (via correlation combinations) and a long-term perspective. Explaining these concepts to clients is often the easy part. The real challenge is guiding them through the emotional ups and downs of the market.
Why Investing is Easy (in Theory)
At its core, investing is about setting a goal, determining your risk tolerance, and building a diversified portfolio to achieve that goal over time. The power of compound interest and historical market trends paint a clear picture: stay invested, and statistically, you'll be okay. Returns are more predictable over the long-term than over the short-term when returns can fluctuate wildly.
The Emotional Factor: The Enemy of Long-Term Gains
But then reality sets in. Markets fluctuate, and red numbers on the screen trigger our fear of loss. Suddenly, the well-reasoned plan you spent hours upon hours to create goes out the window in a heartbeat - as if something has really changed. Clients are bombarded with media frenzy, whispers of a crash, and the urge to "do something" becomes overwhelming.
Here's How We Can Help Clients Stay the Course
Focus on the Fundamentals: Remind clients of their goals and the long-term plan. Highlight past market recoveries using historical data. Refer to our fact cards or Portfolio Optimizer PDFs for historical CAGR ranges to support this discussion.
Desensitize to Noise: Explain the difference between short-term volatility and long-term growth. Discourage clients from constantly checking their portfolios. In fact, discourage yourself from constantly checking their portfolios.
Revisit Risk Tolerance: Have honest conversations about risk tolerance during calmer times. Are clients truly invested for the long term, or are they panicking because their portfolio doesn't match their risk profile? Remember, clients are aggressive until they’re not. Make sure they understand the low-end of the historical CAGR ranges of their portfolios. Ask if they could sleep at night should the low-end occur again (and it will).
Be the Voice of Reason: During market meltdowns, be the steady hand that guides clients away from emotional decisions. Reassure them that you're there to navigate the storm together.
During prosperous times, it's wise to remind clients that their portfolio(s) will experience a significant downturn at any moment, just as they are performing well today. Assure them that this is normal and it is okay.
Remember, we're not just managing portfolios, we're managing emotions. By acknowledging the psychological aspects of investing, we can empower clients to make rational choices and achieve their financial goals.