I recently listened to an excellent podcast hosted by my friend Preet Banerjee, who had my acquaintance Dan Bortolotti as his guest. Much of the conversation was about Dan’s fantastic new book, Reboot Your Portfolio, but the topics bounced around a bit, and I was left with a sense of dread about the overall mood.
Listeners got a glimpse into what it is like to give advice to retail clients, and some of the anecdotes about the life of an advisor I thought were particularly telling. Discussion around the fear felt by investors and advisors in the five or six weeks when COVID-19 first hit was harrowing, but I couldn’t help but think that advisors listening in might be misled.
In the past decade or so, a narrative about the role and value of professional advice has included behavioural coaching. The term can include such value-added activities as topping up RRSPs, getting wills written, naming proper beneficiaries, integrating taxes and other valuable things. But the one thing that always seems to top the list is the notion that advisors add value by encouraging clients to remove the emotion from decision-making. This helps clients take a long-term view focused on personal life goals.
While I agreed with almost everything said in the podcast, I was concerned by what wasn’t said. There was a lot of self-congratulation about advisors navigating their clients through the major market drawdown in early 2020, as if it were a given that this would always be the case.
In truth, that drawdown was the shortest bear market in history. As bear markets go, a walk in the park. Mr. Bean could have provided enough comfort and counsel to keep clients invested in that market. While there is nothing wrong with giving credit where credit is due, I think the podcasters were too congratulatory to mainstream advisors. There was also a reference to the global financial crisis of 2007-2009, and both podcasters agreed that it was far harsher than the 2020 experience. Again, the story was that good advisors can help emotionally driven clients stay on course when things get choppy. They can – but that’s not necessarily the same as they will.
That attitude I heard is likely based on what they’ve seen and done in their careers – and those careers embody a time of relative stability. Few advisors today were working in finance during the bear market of 1974 when the OPEC oil embargo crashed markets. In addition, the one-day drop of more than 20 per cent in 1987 was a blip of sorts, but markets were still up that calendar year.
So, the only significant bear markets most people reading this have lived through were: 1) at the turn of the millennium (aka the dot.com bubble), and 2) the global financial crisis. Both were medium-sized drawdowns. But what if we experience something earth-shattering? How will we react? Nobody knows.
If you claim to play a role in modifying behaviour constructively, you will also be prepared to stand up and take your lumps should that behaviour not be what you wanted nor expected.
Here is what I mean by “medium sized.” In the first one, it took about seven years for the S&P 500 to return to its previous level; the index stood at around 1,500 in April 2000 and didn’t return to that level until October 2007. While the previous high was technically reached, it was only a few weeks before the trend reversed and markets began to fall back again. The S&P 500 didn’t get back to the 1,500 range again until February 2013. There was a dip and return, closely followed by a second dip and return, and the net effect was the entire market went sideways for more than 13 years.
Most people refer to the early 2000s as two distinct drawdowns experienced back-to-back, but I would describe both as medium-sized drops. Either way, the net effect, excluding dividends, was no market growth for more than 13 years.
Now, here’s a “what if” for you. Instead of a 50-per-cent drop that recovers in six or seven years, followed by a second 50-per-cent drop that recovers in six or seven years, we have a 60 per cent drop that takes more than a decade to recover. How would people over 70 who cannot add to their nest egg because they have retired react to that? How would young people in the gig economy with very little job security react? How would YOU react?
Imagine you have a $10 million portfolio, with $6 million in stocks and $4 million in bonds. The value of your stocks drops from $6 million to $2.4 million in the first year, so your total portfolio drops to $6.4 million. Bonds remain flat.
Say this happens in 2022 and it takes until 2032 to recover. For that entire decade, your portfolio’s value is always below where it was in 2021! I have a looming sense something like this might happen. A lot of investors may lose faith and sell a significant amount of their investments when markets are down. I hope I’m wrong. Questioning expected behaviour in advance of unprecedented events is part of what to anticipate in a deep and prolonged bear market. But what will advisors say about their role if a major pullback occurs, only this time investors panic?
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Advisors are quick to take credit for their role in constructive behaviour modification when clients stay cool and don’t do anything rash in a garden-variety pullback. But credibility and accountability cut both ways.
Anyone who accepts credit for their clients’ (presumably good) behaviour in a modest pullback should also be accountable – for better or worse – for their clients’ behaviour when the pullback is severe. You’re either modifying behaviour or you’re not. It follows that if you claim to play a role in modifying behaviour constructively, you will also be prepared to stand up and take your lumps should that behaviour not be what you wanted nor expected.
My final thoughts include an admission and a warning.
First, the admission. My concern is merely about a hypothesis that has never been tested. We may not have a major, prolonged pullback in our lifetimes, so the credibility of many of today’s advisor-value propositions may never be challenged. However, if there is a major pullback and the theory is tested, I want it known that I called it “bullshift” before the pullback occurred. Bullshift is a word I coined to describe the personal finance industry’s tendency to shift investor attention toward bullish outcomes. Until now, bullshift has been a good thing. Staying invested when markets bounce back quickly produces positive outcomes.
Now the warning. Advisors are human. Like all humans, advisors have biases. One of the most pervasive advisor biases is optimism bias. Most of the time when markets go up, sideways or down a bit for a while, that bias serves everyone well. Despite what advisors tell you, no one knows how they might act in a depression-like environment because they haven’t experienced it. Thus, advisors’ role in coaching people to modify their behaviour has not been fully tested. Until now, financial bullshift has always been for the better. Optimism prevails. But who knows what the future holds?
John De Goey is an IIROC-licensed portfolio manager with Wellington-Altus Private Wealth (WAPW) in Toronto. This commentary is the author’s sole opinion based on information drawn from sources believed to be reliable, does not necessarily reflect the views of WAPW, and is provided as a general source of information only. The opinions presented should not be relied upon for accuracy, nor do they constitute investment advice. For proper investment advice, please contact your investment advisor. John De Goey can be reached at firstname.lastname@example.org.
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