When you meet with your clients, whether for the first time or for their annual review, no doubt one of the first things you discuss with them is why they want to invest and what are their goals. It is unlikely they will tell you that their goal is to invest in, for example, emerging market equities, or to make a return of 8% over a five year period. Instead they will tell you what life event they want to invest towards, such as retirement or to finance their children’s education or wedding.
Investing in financial markets can be a powerful way to help your clients grow their wealth and achieve their life goals. But in doing so, they need to have the confidence to invest over the long term. Confidence which may have been undermined by the fluctuations in investment returns over the past decade and in particular in recent months.
Clients often act on how they feel
Naturally none of us want to lose money and indeed, extensive behavioural research by economists Daniel Kahneman and Amos Tversky suggests that people are typically loss-averse. That is, they tend to prefer avoiding losses to acquiring equivalent gains. This behaviour can often result in clients acting on how they feel and not on knowledge, i.e. acting on their fear of losing money when markets turn sour and as such losing the sight of their long term goal.
When the markets are performing well and the only direction for investments seems to be up, it is easy to get blinded by the high growth potential offered and forget the alternative. But it is important to remember that the greater the potential return, the more risk an investor takes on; alongside, of course, an increased chance of significant losses when the going gets tough.
Helping clients keep their eyes on the ball
And so, not fully understanding investment risks can lead to investment decisions that result in poor outcomes relative to people’s hopes and desires. It could also simply deter them from investing at all or decide to ‘run’ when there is a downside. It is therefore important that advisers provide that knowledge to help client keep their eyes on the ball and not keep changing tack with every bump on the journey.
Understanding volatility
There are many different types of risk that investors and their advisers need to consider, including the impact of interest rates and inflation. In recent months we have seen market volatility increase. Volatility is a statistical measurement of how widely a range of returns produced by an asset varies from its average over a particular period. Volatility does not go on and off, but increases and decreases depending on market conditions. Generally speaking, if markets are going up the volatility decreases, creating a sense of ‘security’ and steady returns, but when the markets turn south, volatility goes up. Increased volatility is also often related to increased risk and decreased returns.
Diversification can help
One of the key tools to help protect investment portfolios from the effects of heightened volatility is diversification. Put simply, a well-diversified portfolio can help to cushion the effects of market fluctuations if the holdings within the portfolio are spread so that if one falls, the others can potentially offset the losses. With this in mind, there is wisdom in having exposure to a mixture of assets that can reasonably be expected to perform differently from each other; in other words, to perform in an ‘uncorrelated’ way. It is also important to manage the portfolio efficiently and know when to sell or buy investments. As clients often act on emotion, it is crucial that advisers ensure clients are not acting in haste and are not trying to time the market. The data available for us is always past performance and none of us have a crystal ball to know what happens next. The key consideration should always go back to: what is the client’s ultimate goal? Is the portfolio still fit for purpose and aligned to help meet the client’s long term goals? Is it meeting the client’s expectations and risk appetite during their investment term?
In conclusion
Explain all this and help outline the type of losses your clients could experience on their journey before the going gets tough. Providing clients with insight into how their investments work during both good and bad times should result in them having the confidence to remain invested and help them focus on their longer term aspirations. Plus, you will be adding real value to their investment experience.
Help support your clients through volatile times
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Old Mutual International cannot accept responsibility for any losses arising from actions taken or not taken as a result of the information contained in this blog. The value of investments may fall as well as rise and an investor may not get back what they put in.
