Markets are reaching all-time highs in a range of asset classes. Thanks to the strong rise in the past three years, returns over most periods going back even a decade are looking rock solid.
Environments like this can breed overconfidence in your clients, and tempt them into taking undue risk in their portfolios. It may be helpful at this point to encourage them to pause and reflect on what could have the greatest impact on their prospective returns – their own behaviour.
Here are three things to warn your clients about.
1. Don’t get overconfident. As many investment decisions you have made over the last five years have come right, you’re feeling smart and becoming confident about your ability to predict where returns will come from. But you’re not alone in having done well in this period – all asset classes have provided strong returns over the last five years. And strong performance of your investments during a rising market isn’t an indicator or your investment skills. It’s how you behave and how your investments perform during times of market distress that are the sign of a good investor.
2. Don’t underestimate the benefits of diversification. Diversification may sound old fashioned, and returns from multi-asset, risk-managed funds may appear ordinary compared to the hottest sector of the moment. In reality, true diversification across a number of sources of risk and return is both a smart strategy for spreading investment risk and difficult to achieve if you invest directly.
3. Don’t be swayed by recent events. We are wired to give undue weight to the most recent events, but investment mistakes occur when you make decisions based on recent market events. For example, in 2010 the common view was that Australia could do no wrong, so Australian shares was the best asset class to own. With the GFC still fresh in the minds of many investors, global shares were shunned as being “too risky.” In hindsight, unhedged global shares would have provided far better returns for less risk than Australian shares. Similarly, now that unhedged global shares have had three very strong years of returns, many investors are interested in them, yet the best returns have probably been made. Instead of chasing yesterday’s winners, and reacting to the most recent and dramatic news, it’s best to remain patient and stick with the strategy you and your adviser have determined is most likely to achieve your long-term goals.
We often go to considerable efforts to maintain the belief that we’re in control in situations where we really aren’t. It’s the same for investments: no one truly knows what lies ahead in the market. The best you and your clients can do is plan for a range of different possible market outcomes. If most likely future paths point towards your clients not achieving their goals, they may need to reset their expectations – revise their goals, or perhaps change their savings plan to make up for the difference between what they will need and what the portfolio may provide.
