Advisor Resources: Practice Management

Lifeboat drill: Prepare your clients for volatility

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To facilitate better conversations and outcomes amid increasing market volatility, David Clarke, Director, Intermediary Distribution at BMO Global Asset Management Canada, suggests that all advisors be armed with client-facing “emergency measures;” a touchstone to proactively communicate – and reiterate – the dos and don’ts of successful long-term investing.

Letting cooler heads prevail

Prior to a plane taking off, or a cruise ship setting sail from its port-of-call, passengers are walked through a demonstration of the appropriate emergency procedures as a way of preparing them for what they should do in the event of a crisis. By preparing travelers in advance, when safely docked or grounded, it becomes easier for everyone to recall, understand and follow the necessary procedures to deal with the situation.

As a tool for better risk mitigation, Financial advisors can operate along similar lines, by developing an investment-focused “lifeboat drill” to help clients prepare for, rather than grapple with, inevitable market uncertainty.

Client best practices

In order to properly brief your clients, consider drafting a short summary outlining previous drawdowns, sharp price corrections, and flash crashes – and explain the dos and don’ts of navigating these “what if” events. Creating an informal checklist that you review during times of relative stability is an acknowledgment of reality: what goes up eventually comes down. It also demonstrates your commitment to client education, communication and transparency in all environments.

Not only can this resource calibrate client expectations, and serve as a touch-point for future conversations, but it can also improve financial outcomes, given what we know about the impact of behavior and psychology on portfolio performance.

Drafting an action plan

When creating an action plan for difficult market conditions, it’s important to emphasize – and build confidence in – your role as the client’s behavior manager. The goal is to reduce the amount of emotional decision-making which has a tendency to undermine the long-term success of a well-designed investment portfolio. Be sure to re-iterate best practices, such as:

Do stay invested

  • Inform me (or my team) if there is a change in life circumstance, such as job loss, divorce, birth of a child, or a major health event
  • Contact me when you’re nervous about market conditions
  • Annually reaffirm your commitment to the investment plan

Don’t panic

  • Resist the impulse to check your account balances daily
  • Avoid investing based solely on casual stock tips or hot trends
  • Do not prematurely seek to abandon the portfolio strategy

While a standard template encompassing the above suggestions can lend structure to your lifeboat drill, you can always adapt the exercise to the individual client. However, a loose outline provides uniformity to the quality of service you provide, and, conversely, establishes a baseline of what you expect from all clients.

Building a portfolio to match

Inevitably, some people, spurred on by fear, will seek action during difficult times. Advisors can re-direct this impulse by adding a “pledge” to the lifeboat drill committing clients to a long-term, durable portfolio – one that’s capable of withstanding full market cycles without a significant change to the underlying strategy. Changes to the portfolio should be driven by changing personal circumstances, not by changing market conditions.

Whether you’re using an active or passive approach, the goal is to build an all-weather investment plan both you and the client have faith in that performs regardless of the market environment. It’s important to emphasize that equity corrections are not uncommon; over the last 35 years, there’s been a point in every year where returns were negative, even in years where the market had great performance. The solution for long-term investors is simple: to remain invested in equities.

Measured expectations for the upside are equally important: clients must be skeptical of the bubble du jour, and the prognosticators who promote them with absolute confidence.
 
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Frame your value-add

While it may seem counter-intuitive to focus on negative outcomes so early in client interactions, there are several industries where it is a well-established tradition. Personal trainers, for example, do not offer unparalleled insight into fitness, but rather accountability and commitment to a long-term health goal. Similarly, nobody walks into a dentist’s appointment thinking, “this is the best thing to happen to me in six months” – they do it because it’s part of good overall oral hygiene. The lifeboat drill can be viewed through the same lens: clients should be able to see it as a value-added tool, helping them stay on track and attached to sound financial habits, regardless of the market environment.

Have the conversation. Repeat.

The sooner you can begin these conversations, the better. Set aside time in the onboarding process to identify key “what if” questions that might surface in the midst of a market correction. Once you’ve addressed those concerns in a face-to-face meeting, make sure it’s reflected in the tip sheet.

The goal is to provide a realistic set of expectations, across the equity cycle, so if a portfolio underperforms the target rate of return for one year, or two, clients do not feel nervous. And, for the few that do, at least there’s written documentation of the action plan procedures that you can collectively revisit.

Remember, a bracing discussion with clients is like an immunization shot – it works best when the patient is healthy, not when they are ill. If you do it at the beginning of the relationship, it becomes easier for the drill to serve as a value-added touch-point later on, both in annual reviews and times of extreme market volatility.

Getting started

Your lifeboat drill can take shape in any way that best suits your style – e.g., a checklist, a friendly client-facing “contract” composed of dos and don’ts, or a simple cheat sheet to support key talking points:

The expectations

  • Volatility (and market declines) are a reality of investing
  • It’s natural to feel nervous in times of uncertainty
  • My approach/investment philosophy is designed to weather inevitable storms
  • Historically, bull markets follow bear markets

The plan

  • Your financial plan is sound and has been created to reflect your personal long-term goals
  • Your changing lifestyle needs might impact the plan – but short-term external factors/market uncertainty SHOULD NOT
  • Your portfolio is thoughtfully constructed to reflect your objectives and risk tolerance (the right mix, the right managers, the right strategies)
  • Discipline, insight, and regular review to ensure the portfolio and your goals remain aligned, is how we’ll stay on course

The agreement

  • In the event of market turbulence, let’s revisit the above and agree to:
    • Stay invested (See Do’s)
    • Not panic (See Don’ts)

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