Only 27 percent of clients with financial advisors, 401k and otherwise, have been told how much their portfolios could lose if there was another market crash.
Of those that had “the talk,” 62 percent said their loss would be less than what their stated exposure to equities would suggest, according to a new survey released by FinMason, a Boston-based financial technology and investment analytics firm.
“This is setting up the same way as it always does,” Kendrick Wakeman, CEO and founder of FinMason, said in a statement. “The market will eventually crash, maybe not today or even soon, but when it does, investors will feel upset, betrayed and litigious.”
Why is it a problem (beyond the obvious)? Human behavior. The survey also found that up to 57 percent of clients will likely panic and sell on the next crash. Investors were asked two questions: first, how much they could stand to lose in a decline before they felt compelled to sell everything and second, what percentage of their investments are currently in the equity market.
Assuming that the next crash is similar to 2008 in terms of equity price decline, the equity portion of an investor’s portfolio would produce a loss in excess of the stated sell level in 57 percent of the investors.
“I understand that many advisors don’t want to potentially scare their clients with talk about possible volatility in the market,” Wakeman said. “But, if an advisor has a conversation about a crash now, in the light of calm markets, they can have a very rational discussion of why it is important to take that risk. The advisor can form a clear mental link between that risk and the potential rewards, like having a higher income in retirement. That turns a potentially scary conversation into a healthy and productive one. The investor now knows how much they could lose and agrees that it is important to take that risk to achieve their ultimate rewards.”
Wakeman points out that some psychological studies show that surprise heightens emotional response by 400 percent.
“That is why surprise birthday parties are so pleasant and surprise tragedies are so tragic. By foreshadowing what could happen in a crash, an advisor can help the investor be more centered, and perhaps less emotional, when the emotions of a crash start raging.”
“Having a realistic conversation about risk allows advisors to show the value they bring to the table,” Wakeman concluded. “It’s an opportunity to anticipate what could happen in a crash before it occurs, thus eliminating (or at least reducing) the emotional, sell-off response. It’s in the best interest of both advisor and client to avoid a situation where the client feels tricked or that their world is collapsing.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
