Recently, there has been much commentary on rising interest rates and inflation and the impacts on investment returns and your clients’ outcomes. There have been very few sectors which have produced positive returns in the last 12 months and so the impacts have been felt across the range of investor profiles. No one has escaped unscathed.
It can be challenging in these conditions to feel confident that your advice is delivering value to your clients. While we like to think that we (and our clients) make rational decisions when it comes to investments, this may not be the case due to information, cognitive and time limitations. Nobel prize winning political scientist Herbert Simon proposed the concept of ‘bounded rationality’ – as humans we make partly irrational decisions due to cognitive, information and time limitations.
There is an abundance of information and commentary, some of it consistent, some contrary and markets and the macro environment seem to move more quickly than ever. The speed of recent inflation increases, and corresponding interest rate movements, have caught many by surprise.
With this as the backdrop, it is important to consider the context of the advised client and the role that advisors play in a service that is now of more value than ever.
Below are some possible conversations that are occurring with your clients. How do you think through and respond to these rationally?
Do I move funds to cash or dilute my current risk tolerance?
It’s not rational that you can time the markets or grasp how much downside the market has already factored in. Are we at the bottom of the cycle? Can longer term compounding inflation impacts be met by changing to a more conservative asset allocation?
During the GFC in 2008, clients moving to cash locked in an average loss of 8.5 per cent. These loses were compounded as many of these clients stayed in cash and missed the corresponding market rebound. Research from Vanguard indicated that in a US diversified portfolio of 50 per cent equities and 50 per cent bonds, not sold down, saw an average return of 7 per cent between pre-GFC peaks and the proceeding 11 years. Understanding the long term impact of investment decisions is one of the key values of advice.
Your advice value?
Clients invest for a purpose which your advice and strategy is designed to deliver. Your value in assisting clients stay true to that course and not falling into an irrational decision cycle should not be underestimated. Has the strategy changed, are the client’s goals still relevant? Has the clients risk appetite changed, if so, is this an elastic response driven by current state or a deeper permanent shift?
Like advisors, my GP is a professional that has my long-term interests in mind, in their case my health. I am not convinced they would call my decision to reduce my prescription by half or my decision to cease all medication for an extended period a rational choice. It would be a decision not without consequence for my long-term health.
The long game
From a client and business risk perspective is it appropriate to move in and out of client strategy in the hope that we are finding market highs and lows? There will always be market troughs and peaks and many factors outside of your control. Is it rational to make tactical moves at every market shift? In the long game your controllable’s become the client, education, communication, engagement and reaffirmation of objectives and goals and your strategy.
The importance of clarity and context
How do we recognise and replace irrational decisions with rational ones?
One solution is a considered, clear, and articulated investment philosophy. Your investment philosophy is a reference point that reminds you (and your clients) of your fundamental investment beliefs. These are rational beliefs that in times of stress can be replaced with irrational ones and provides clarity when you need it most.
Be clear on your value and remind clients of this value in every conversation and decision made. Be clear in your investment philosophy, be great at revisiting goals, be good at assisting your clients in staying the course and have confidence in the resilience of your advice. Effective strategic advice creates immediate and long-lasting client value. Its positive impact will linger long after the market cycle has shifted.
