In reaction to the latest bout of market volatility, Jack Bogle, of Vanguard commented: “I’ve never seen anything like this.” Could the founder of passive investing and the firm that dominates the $4.6 trillion ETF market, which makes frequent trading cheap and easy, be part of the problem?
Advisors initially set their clients’ Risk Tolerance using questionnaires that ask about time horizon, age, income needs, desire for extra gains and willingness to have an unrealized loss of principal. What advisors don’t always communicate well is the perceived risk in the portfolio. They often fail to understand how clients will react in times of extremes; that is, many advisors don’t comprehend their clients’ Risk Composure.
Investors should have an understanding of their own behavioral biases when Fear and Greed drive the market. If you have High-Risk Composure you can handle the risk when markets get volatile. It doesn’t guarantee you will make good decisions, but at least you will have a degree of comfort with the risk you are taking. A problem to address is when clients have a poor understanding of their own perception of risk. A Low-Risk Composure investor is more likely to change their risk tolerance in reaction to events. This group is most likely to suffer from bad decisions.
Tools and probing questions can help clients develop a better gauge of their true risk profile as investors. Portfolio returns can suffer, and long-term goals may have to be adjusted when individuals choose to ‘go it alone’ and invest without the help of a professional advisor. Many investors hold accounts in custody relationships where a phone center support group or a rep with hundreds of accounts is their partner. Or people have 401k/403b accounts that are long-term assets but are under-invested because they misunderstand market risk.
The cost differential between good advice and no advice that results in under-investment or poorly-timed decisions favors working with a professional partner. We know that both cost and returns matter.
John Kirby is Principal and Co-Founder of Laurentide Advisory