Preparing clients for the next bear market

The greatest value we add as financial advisers is keeping clients from making mistakes from which they cannot recover.

After 30 years in this industry, I’ve certainly seen my share of market euphoria, but I’ve never seen the likes of this.

We’re in the midst of a global pandemic with much of the economy in tatters, our political system is a mess, and yet the stock market continues to hit new highs. Other surreal happenings include Elon Musk being elevated to a deity of sorts, valuations of startups being worth more than entire industries, and day traders trading options on gamified apps.

It all feels as if there’s a complete disconnect between reality and valuations.

Now, I understand some of the underlying reasons why investors are bidding up prices of risky assets, and I’m certainly not trying to predict when this bull market will end. But I feel we have a duty to our clients to help prepare them for whenever it is that this stock market corrects.

In the past 20 years we’ve experienced two prolonged, nasty bear markets. The one beginning in March of 2000 lasted 2½ years and wiped out nearly 78% of the value of the Nasdaq and roughly 45% of the S&P 500. The downturn of the Great Recession lasted 1.3 years and pulled the S&P 500 down by more than 50%.

The pandemic-inspired decline that we experienced early in 2020 was so short-lived that it didn’t have the same impact on investors as previous bear markets. Rather than the months or years of previous declines, retirees and other savers saw their accounts begin to recover in a matter of days.

Given its short duration, the odds are that the majority of your clients did not sell equities at the worst possible time last year. Most stuck with their investment plan and enjoyed a nice recovery followed by another bull market. Yet there were probably a handful of clients who listened to their fears, threw in the towel on their plan and took what should have been a temporary decline and turned it into a permanent loss of capital.

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I’m convinced that the greatest value we add as financial advisers is not in the picking of proper investments nor is it the financial planning. The greatest value is keeping clients from making mistakes from which they cannot recover.

As financial advisers, I believe we have a fiduciary duty to remind our clients of what has occurred in recent history and, by inference, what could happen again — not to convince them to shed their equities, but to help prepare them for what may occur in the future.

When the markets are riding high, I’ve used my client reviews to show clients how bad things could get to help steel them for the next bear market. There are some great tools available today, such as HiddenLevers and Riskalyze, that will show clients, in dollar amounts, what to expect during various declines.

Further, I’ll illustrate to clients how much of their portfolio can be invested for the long term. As an example, I’ll highlight those investments that are not tied to the stock market and then project how many years those can provide for their income needs without having to sell any stocks.

My experience has been that if advisers employ these tactics, clients are not surprised when the downturn comes. They’re ready for it, and prepared to ride out the bear markets and capture the gains that have occurred with the ensuing bull markets.

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Scott Hanson is co-founder of Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA with $8 billion in AUM.