My job as a financial advisor is to help my clients make sound money decisions, large and small. Recently, all these decisions have taken a back seat to one question: where to invest my money. Never in my 26 years as a financial planner has that task been more challenging than it has in the last nine months.
In the past, this decision was a relatively easy one for my clients. I would present my well-researched case for investing in a variety of mutual funds in nine different asset classes. Further research suggested the best portfolios for younger people were heavily weighted toward equities, while retirees were better served by portfolios with 60 percent in “owned” assets and 40 percent in “loaned” assets. Add monthly rebalancing, and this investment strategy produced stellar results for clients for 26 years.
In my career, I’ve had very few clients ever panic at a market bottom or buy into an overheated market at a euphoric top. I have, however, been able to accurately gauge most market tops and bottoms by observing clients’ behavior. When more than five percent of them wanted to sell out of a falling market or buy into a rising market, we’ve typically been near or at a bottom or a top.
This year was a huge exception. Over 20% of my clients reduced their allocations to stocks. Most did so during the week the market bottomed in March. Not one client—myself included—actually increased their allocation to stock at the bottom.
That reaction comes as no surprise to anyone who has studied behavioral finance. Research proves people’s behavior around investing is very predictable. A high percentage will typically sell stocks when a market is bottoming and buy stocks when the market is peaking. Without conscious intervention, our brains are hard-wired to react this way to fear, which is typically running rampant at market tops and bottoms.
During that week in March, my goal was to keep clients who wanted to sell from bailing out altogether. We achieved this with compromises that reduced equities rather than selling all of them. I kept reminding clients about the importance of being in the market when the bottom occurred in order to take advantage of the rebound. Rebounds tend to come quickly, with most of the return in the following three years occurring in the first six months of a rebound.
Since the March bottom, the stock market has had the sharpest rise in the shortest period of time in its history. Those who maintained a moderate allocation to equities through the lows saw their portfolios increase 20 to 30% from the March bottom by June 1. Those who reduced their allocations to equities at the market bottom saw their portfolios increase only one-fourth to one-half that amount. A person with $1 million who reduced stock allocations at the bottom cost themselves $100,000 to $250,000.
That’s enough to make a financial advisor cry. I found myself wondering whether I could have done more to dissuade those who sold stocks at the bottom.
Of course, I have no idea if March was really the market bottom. It’s possible that in the months ahead, we may even see lower lows. What I do know is how much anxiety results from trying to second guess short-term market movements.
So far, clients who have stuck with their original allocations have fared better, both financially and emotionally, than those who did not. My hunch is that maintaining a well-diversified portfolio with five or more asset classes will continue to serve most investors for years to come.