By Lisa Brignoni, CFA

“I heard the Dow hit 25,000, now what?”

“How will my portfolio generate income in this low interest rate environment?”

“How will the slowdown in China affect my portfolio?”

Clients have many questions about the markets and how they affect their investments. Though most financial advisors stress the importance of goals-based financial planning, market and economic expectations will inevitably enter the conversation. How can advisors address these questions without dismissing client concerns or getting caught in the weeds?

According to a Natixis survey,* clients expect returns of 9.5 percent over inflation, while advisors believe the reality is closer to 5.3 percent. With such lofty expectations for the performance of their investments, clients may be inclined to take on greater risk than needed to achieve those expectations or may be overconfident about their preparations for retirement. In either case, these scenarios can lead to counterproductive client behavior without an experienced advisor clearly explaining the reality of market return expectations.

Now, knowing the answer to every possible market question your client will ask may seem impossible and counterproductive, but being prepared to steer smart market conversations to address your client’s underlying concerns is not. Advisors can set up a framework for weaving these market questions in to the bigger financial picture with a few key themes:

  • Articulate a top-down investment approach by translating the market cycle into market strategies
  • Sort out the major indices and their implications for the client’s investments
  • Address short-term market reactions in the context of the bigger financial picture
  • Clearly define long-term versus short-term expectations
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Articulating a top-down approach through market cycles

As mentioned above, individual investors have return expectations of 9.5 percent above inflation, while advisors say that number is closer to 5 percent. Perhaps this exuberance is due in part to recency bias. During the current eight year bull market, 6 of the 8 years produced double-digit growth in the S&P 500. This wide gap in expectations between advisor and client can prove problematic if clients make financial decisions based on their loftier expectations.

To bridge this gap, advisors need to explain return expectations and strategies over the course of full market cycles as well as explain where we actually are in the current cycle. Advisors can articulate this using macroeconomic data – indicators that show which stage of the market cycle is currently in play (recovery, expansion, slowdown or contraction). We also know that as the economy moves through these various stages, asset classes have been shown to perform differently. Armed with this information, advisors can temper expectations of their clients and provide a plan for investment decisions to underweight and overweight certain asset classes in the context of their long-term asset allocation.

Sorting out the implications of the major indices

Major Indices

The S&P 500, DJIA and NASDAQ are frequently reported indices in the media and most clients are familiar with these terms. They generally know what the current levels are and where the next threshold is, but the implications for their portfolios are often not as clear. This confusion can lead to irrational decision making in the absence of a knowledgeable advisor.

Investors recently cheered the Dow hitting 25,000, but few questioned the underlying economic and market trends that brought us there. Is it reasonable to assume that the sole cause was the presidential election and expectations for government policies, or was it due to combination of factors? If the latter, then what were these factors and how are they correlated? Answers to these questions provide more substance for the investor in terms of what they can expect in their own portfolios because it is these same trends that will clue them in to the future direction of the markets and inform asset allocation decisions.

Indices like the Dow, only tell part of the story for investors with globally diversified portfolios. They represent different composites of the large cap U.S. stock market. By adding other indices such as the Russell 2000 and MSCI EAFE and the factors that drives these indices to the discussion, advisors can convey a more complete picture of what’s driving returns in their clients’ portfolios.

Visit the stock market dashboard for index charts.

Addressing short-term market reactions

Markets will always continue to react to new information – whether it’s positively, negatively, strongly, or subtly – and especially when reported results are not in line with previously held expectations. Looking beyond daily or weekly market developments, especially the negative ones, is an emotional hurdle that many advisors struggle getting their investors over.

Many clients have become weary of unsatisfying explanations that are dismissive and direct them right back to the financial plan, but advisors also struggle with explanations that tend to go too deep into the weeds. The challenge is to clearly explain the short-term reaction and move along with the rest of the conversation without falling down a rabbit hole of investment strategies and advanced market concepts.

Whether it be Brexit, China’s slowdown or the recovery of oil prices, each market development can be analyzed and discussed with clients using the following questions:

  1. What is the market development and its underlying causes?
  2. What asset classes are primarily affected and how are they affected?
  3. Does this development shift fundamentals driving long-term economic trends?
  4. Is a change in strategy warranted?

Clearly defining long-term versus short-term

Having a multi-year focus has paid off
S&P 500
Source: Standard & Poor's

A common theme that comes up when discussing the challenges of market conversations with financial advisors is focusing on the long-term. With a constant battering of sensational headlines about market news, advisors are constantly coaching their clients to see the forest for the trees by redirecting their focus on long-term goals and market expectations. But what happens when the two parties can’t agree on what is long-term versus short-term?

I once observed a market conversation between a financial advisor and client where they had mismatched perceptions of what constituted “long-term”. Nervous about the current global uncertainty and the market pullback that was a result, the client was urged to focus on the long-term market performance. However, the client considered eight years to retirement to be short-term and had difficulty getting past that fact to hear the advisor through.

Since “short-term” and “long-term” can be relative, describing these concepts in terms of the market cycle can be a more effective way of communicating. Basic reference points based on data starting from 1900 can be used to clarify the mystery between short versus long:

  • Average contraction lasted 1.2 years
  • Average expansion lasted 3.8 years
  • Average market cycle is 4.9 years

Source: NBER

Final Thoughts

Markets are complex and clients want to make sense of it all. They want to understand how the changing market environment is going to affect their progress towards their financial goals. Advisors need reliable tools and strategies for delivering clear and relatable explanations time and time again.

Additional Resources