In my last column I talked about fear and investors who wanted to get out of the market. My advice (don't do it) was based on valuation, investor sentiment and the difficulty of timing the market. It was aimed at helping the investor make the best decision.
But what about the investment professional? What is the best reward-versus-risk tradeoff for the adviser in a situation like this when he doesn't agree with a client's strong view? Indeed, he might even believe the strategy could do some real harm. These are the times when advisers and investment managers earn their keep.
In an ideal world, the recommendation to stay the course would be based on an assessment of potential returns and risks. The client would know that the advice could be wrong, but if the two of them are disciplined about always putting the odds in their favour, then the long-term results will be good.
Unfortunately, investors don't always get what they pay for. In a challenging situation like this, advisers too often provide little resistance, making it easy for clients to go with their emotions. (Note: I'm not implying clients are always wrong, but am assuming that if they have an adviser they need help.)
While I'm often quick to criticize our industry for not having enough of a backbone in such cases, I recognize that the professional has a different reward/risk equation than the client. And the disparity makes it more difficult to provide the appropriate advice.
Let me explain by using the example of when I disagreed with my worried client. We'll assume I talked her out of selling all her stocks. She may be right at the end of the day, but I didn't think it was in her best interests to make such an extreme shift. So we trimmed back on her equity holdings, but basically stuck close to her long-term asset mix.
Now that we've tried to maximize her odds, what does my situation look like?
Well, if the markets hold steady or go up over the next six to 12 months, I have a happy client. She's made some money and our relationship has moved up a notch on the trust and confidence scale.
If, on the other hand, markets go down and the portfolio valuation drops, then my client is upset. She felt strongly about selling, but I talked her out of it and it cost her money. If the market takes a big dip, then she may be dissatisfied enough to take her account elsewhere.
While I truly believe I'm giving her the best chance of succeeding, my reward/risk balance is not so favourable. I have potential upside for sure (better returns and a stronger relationship), but the downside is far greater. I risk losing a client for good.
To improve my prospects, I could take a different tack. I could voice my concern about the "bail out" strategy, but then get out of her way. Call it the "Olé approach." If markets go up, my client misses out on the gains, but I'm on record as having advised otherwise (albeit feebly). If markets go down, she's happy, and while she may not give me much credit, our relationship lives on. In the short term at least, I've enhanced my business.
This is an extreme case obviously, but there are many situations where the best intentioned advisers or managers have the incentive to water down their expertise. It's just too risky, from a business point of view, to push back at clients when they feel strongly about something.
When this happens, neither side is getting what they need. Clients aren't receiving the steady, thoughtful advice they're paying for. And advisers are weakening their businesses in the long run, especially now when investors have plenty of low-cost, advice-lite options to go to.
What can clients and advisers do about this reward/risk imbalance?
Clients can ask questions with the intent of listening to the answer. They can ask what the adviser is doing in his own account. And, ultimately, they can take responsibility for their actions.
The paid professionals can focus on keeping their interests aligned with that of their clients. That means matching up their recommendations with what they're doing in their own portfolios. They can use the good times to prepare clients for the inevitable situation when there is a fundamental disagreement on strategy. And they can remind their clients that those disagreements are what they're paying for.
Tom Bradley