More than four years after the financial crisis, it is increasingly clear how traumatized individual investors were by the market volatility of those years and the portfolio losses that they suffered.
It also is clear how difficult it will be for financial advisers and other financial professionals to help these clients take steps to act in their own best interests. But now is the perfect time for advisers to re-engage with clients, to reflect on past experience and look for innovative ways to build more-durable portfolios.
Industry data show the depth of the trauma suffered by investors. In 2008, the S&P 500 lost 37%, knocking many investors' portfolios down significantly.
As of Dec. 31, 2012, the market was up by 129%, on a total-return basis, including
dividend reinvestment, since its low on March 9, 2009.
Despite these returns, investors withdrew more than $265 billion more from open-end domestic equity funds during that period than they put in, according to Strategic Insight.
Although flows to equity mutual funds show early signs of reversing this year, many investors remain overly allocated to cash and other low-return instruments.
SPOOKED BY VOLATILITY
What is going on? Over the past year, Natixis Global Asset Management surveyed 5,319 investors and 341 advisers and found that investors were deeply affected by their experiences — something that advisers recognized.
More than 7 in 10 investors (71%) told us that volatility has damaged their confidence in the markets, more than half (52%) said volatility undermines their ability to achieve their goals and about half (51%) said they have lower expectations for future returns.
So even as the U.S. stock market marches toward a fourth consecutive year of gains, many investors continue to remain paralyzed by indecision or display behavior that undermines their long-term savings goals.
Two-thirds of investors surveyed (67%) said they can't decide whether they should invest to obtain return or to preserve capital, and 57% said they don't plan to change their cash allocations, even while recognizing that the low returns they are earning will limit their ability to reach their financial goals. More than half of investors (56%) said they invest or save less than they otherwise would because they fear losing even more money.
The end result is that investors become mired in a cycle of fear, passive investing and low returns, all of which limit their potential for growth.
So how can advisers help their clients overcome this nervous, defensive investment philosophy?
Although most advisers have probably not thought much about classical psychology since college, there are certainly a few proven techniques that they can use to help their clients.
Psychologists routinely engage in discussions with their patients about their past experiences, interpret the meaning of those experiences and offer solutions to help patients overcome their challenges. That is exactly what the best advisers do with their clients.
Do all advisers need to take a refresher Psych 101 course? Not exactly. But for many clients, the road ahead is shaped by the past.
Advisers need to engage their clients in frank discussions about their expectations and fears. They should help clients understand the sources and drivers of risk in their portfolios.
Once risk is understood, the adviser can work to seek maximum returns, given the risk that the investor is willing to take. By eliminating myths and mysteries around risk, advisers can help their clients return to the markets and avoid surprises.
Investors, battered by market declines and fearful of the future, are looking to their advisers for assistance. More than 6 in 10 investors surveyed (62%) said that they are more interested in discussing risk with their adviser than they were before.
Of course, understanding is only part of the healing process. Investors need to recognize how and why they were traumatized, and advisers need to have a road map to identify investment strategies that help their clients re-engage in the markets.
Advisers should achieve this goal through a more durable approach to portfolio construction that is designed to focus primarily on risk. Durable portfolios draw on an array of asset classes, including alternatives, that potentially can help investors manage risk, stay in the market despite unpredictable conditions and earn consistent long-term growth.
MISSED OPPORTUNITY
Most investors are willing to consider new strategies: Nearly 7 in 10 of them (69%) said that they want to replace traditional techniques with new approaches.
Yet, though half of the investors surveyed (51%) said that they would consider alternative investments such as hedge funds and
private equity for their portfolio, just a third (35%) said that they have discussed such alternatives with their advisers. This is a missed opportunity for advisers to proactively help clients address their fears and insecurities.
What is the next step for advisers and their clients? Sit down and talk.
Clients need to communicate their expectations and concerns honestly. Advisers need to explain the various options available to their clients clearly and help them negotiate the fears and anxieties that they have acquired through past experience.
The result will be better communication and, ultimately, better financial results.
David L. Giunta is president and chief executive of Natixis Global Asset Management - U.S. Distribution.
