The year started with a bang, and it's been a wrenching, unstable ride ever since. We continue to experience exceptional levels of market uncertainty, with large, daily swings in the major market indexes.
Advisers regularly caution investors that markets go up and markets go down. How closely clients listen when it seems as if the markets can only go up is — as we all know — somewhat open to question. One thing's for sure: In unsteady times like these, when reality hits with a vengeance, the confidence of any retail investor can be sorely shaken.
This is especially true when it comes to your clients who are already in retirement or right on the cusp of entering retirement. Will they need to reenter the workforce? Should they switch out of their long-term investments and go to cash or into more conservative vehicles? Does it make sense for them to change their strategies to increase yield over the near term?
When clients ask these questions at such potentially life-changing times, an adviser must offer more than simply hand-holding and emotional comfort.
Rather, this becomes a good opportunity for advisers to stress-test the financial plans they have put in place for their clients, helping them shift their attention away from daily market performance to what should always be the real focal point: Is my plan on track?
Here are the top four things to consider when evaluating a financial plan to make sure it is performing as intended during market downturns:
1. Test the plan's assumptions. All too often, financial advisers operate according to rules of thumb, such as drawing down 5% a year, or 4%, to ensure that a portfolio's assets will last over time. But the correct thing to do is to perform a more rigorous Monte Carlo simulation on the portfolio. This model cannot determine how much a portfolio will be worth at a future point in time, but it can provide a range of likely results and the probability of a desired outcome.
2. Review the cash flow. The client's cash flow — along with other sources of income — will determine how much money the client will safely have to spend on a regular basis. Each financial plan should predict a minimum or “acceptable” level of cash flow needed to satisfy the client's basic expenditures, as well as an ideal level of cash flow that would meet all the client's desired outlays. The closer the plan's cash flow is to the minimum level, the greater the risk that it may fall below that benchmark during periods of stress. At the least, this would necessitate making changes in the portfolio's allocations. It also might necessitate making more impactful decisions, such as delaying retirement for six months or even a year.
3. Review discretionary spending. This requires discussing with the client what is “nice to have” and what is a “must-have” ongoing expenditure. Such a discussion should lead to prioritizing all these expenditures in order to uncover which expenses the client can most readily eliminate to save cash without being particularly missing them.
4. Review nondiscretionary spending. There are certain things that everyone needs — food, clothing, shelter. But even within this nondiscretionary category, many re-evaluations and substitutions can be made. This may include everything from reconsidering which cuts of meat one eats to whether or not one should sell the family home and downsize.
Finally, financial planners should make sure they are utilizing a methodical, comprehensive system when reviewing a client's financial plan. This should include a formal set of steps to help articulate and populate the plan, and make sure the plan stays on track.
A good system should first help the client define major life goals, determine realistic and acceptable objectives to achieving them, prioritize these goals and then stress-test their achievability. From there, the system would assist the adviser in making investment recommendations and deciding how to allocate these investments while incorporating other funding sources into the plan.
Once these goals and enabling actions are implemented, advisers will need to monitor the plan's progress regularly, as well as add new goals, reprioritize current goals or further customize the plan as life unfolds.
Implementing these actions can help keep clients calm and focused during troubling times in the markets, and will offer a comprehensive way for your clients to pursue optimal financial outcomes in their lives — which is ultimately the financial adviser's foremost goal.
Chad Smith is a wealth management strategist for independent broker-dealer HD Vest Invest.