Bear markets happen. And even though stock and bond market declines have been more like whiplash events than enduring periods of wealth destruction, your clients still need you to speak straight to them about threats to their retirement objectives.
There is no better way for financial advisors to prove they are truly putting their clients first than to prepare them for the range of possible investment climates. If you can eliminate the element of negative investment surprise, you may outshine many of your competitors. That will matter when the proverbial dung eventually hits the fan.
Here's how advisors can succeed, even in the ugliest of bear markets.
A bear market is defined by some in the advisory industry as a decline of 20% from a high point to a low point.
That is perhaps the least helpful definition you could possibly present to your clients. It misses the point of what a bear market truly is: a combination of lower lows and lower highs in prices, or a downtrend that progresses from routine and dry to dramatic and emotional.
A 20% drop occurred in a matter of days in early 2020, and in about three months in late 2018. Both were over too quickly to strike true, lasting fear.
Some would call those bear markets and declare that it hasn't been very long since we had one.
Let them delude themselves. The last true bear market for the S&P 500 was from the fourth quarter of 2007 through the first quarter of 2009. Over 18 months, it included a decline of more than 50% from the high and a transition in investor mentality from "I love equities" to "I won't invest in certificates of deposit because they are too risky." That is a bear market.
One common myth is that bear markets are part of being a long-term investor, and you should simply stay patient and fully invested in your plan throughout those phases of the market cycle.
Tell that to the investors who retired in 1999 and were still waiting to break even 10 years later. Repeat that to those who thought they were in good shape back in the early 1970s, only to see both stocks and bonds crash and fail to recover for many years.
Let's face it: The advice to "just hang in there" has a lot to do with big financial firms' goals of keeping their asset bases from fleeing when markets go south.
Confronting bear markets is not for everyone. But for those advisors who want to help their clients pursue their objectives with less drama and more confidence, bear market preparedness is as important as any aspect of your practice.
Some investors think that stocks have bear markets and bonds don't.
Advisors who worked in the industry during the financial crisis or dot-com bubble know what a stock bear market is like. Those were periods of many months when the S&P 500 was at about half its all-time high. Sure, the market came back and reached new highs, but that took years to occur.
Bonds have not experienced a sustained bear market in more than 40 years, which is exactly why that market is more primed for a bear.
Rates are so low, and spreads of non-Treasury bonds over Treasurys are so tight, that bonds are more likely to produce low positive or sustained negative returns in the coming decade. That will shock investors.
Most of your clients know stocks are volatile. But they don't realize how volatile bonds, which are the allegedly "safe" and complementary piece of their portfolio, can be. Like with equities, a bond bear market has the potential to destroy wealth, both before and after inflation is factored.
You cannot start planning to endure a bear market when it is apparent to everyone that a bear market cycle is in progress. It is all about proactively factoring in something many advisors don't: A bear market cycle can occur at any time.
So, how do you prepare for the bear, even if you might not see one soon?
It starts with trading in the traditional "quarterly rebalancing asset allocation" approach for a more flexible approach to asset allocation.
One way to think of handling your clients' life savings and retirement dreams involves developing a process that admits what advisors already know: Nearly every long-term growth investor wants to be a capital-preservation investor as soon as they are staring at the threat of severe portfolio losses. So, why not cater to that in a proactive way? Anything else is gambling on the recovery potential of the bear market in question.
Most specifically, this is about having multiple scenarios for how your client would be invested, based on your assessment of the risk of major loss.
The tool kit for this involves a few things. It includes a methodology for measuring risk of major loss. (Hint: The higher the market's valuation, and the more meme stocks dominate headlines, the higher the risk of major loss to follow.) It has developed multiple scenarios (up to seven or more) and a predetermined plan for how your clients' allocation to stocks, bonds, hedging methods and other assets will vary. Finally, it combines the risk-assessment system with the moves to make as major risk cycles up and down over time. This is an active strategy, but it does not have to be hyperactive. It is not a set-it-and-forget-it strategy.
Your clients don't want to risk losing a big chunk of their fortunes. And when the next bear market strikes, their trust in the markets to recover, and for you to be their financial shepherd, could be damaged. You can choose to be reactive or proactive.
Will this increase clients' long-term returns? Maybe. But if executed properly and consistently, including with full communication, education and transparency to the client, in words they can understand (not jargon), it might just save your best clients from turning into your most challenging clients.