Clients often live in fear of another black swan event like the financial crisis of 2008. This fear can serve to keep clients from taking the steps needed to effectively meet long-term financial goals such as retirement. In a 2017 Greenwald & Associates study, 55% of pre-retirees indicated they are concerned about major market declines impacting their retirement.1
Financial professionals should talk to their clients who are fearful of such a financial crisis to both help calm their fears and to ensure they are onboard with the type of long-term planning required of them.
Black Swan event versus normal market correction
Investopedia defines a black swan event as “an event or occurrence that deviates beyond what is normally expected of a situation and is extremely difficult to predict.” The term was initially coined by former Wall Street trader Nicholas Taleb after the 2008 financial crisis.
Examples of recent black swan events include:
- The 1998 collapse of hedge fund Long Term Capital Management caused a roughly 18% drop in the S&P that occurred in roughly one month and a half. The market recovered from these losses by late November of that year and went on to reach new highs through early 2000 when the next black swan event hit the market.
- The S&P 500 went on to hit a new high in March of 2000, only to experience a 49% drop through early October of 2002. The initial black swan event that led to this drop was the bursting of the dot-com bubble where a number of tech stocks crashed dragging down the entire stock market. This decline was further exacerbated by another black swan event: the 9/11 attacks.
- From its bottom in October of 2002, the S&P 500 went on to gain 101% and reach a new high in October of 2007. This was followed by a 57% decline in the index caused by the financial crisis of 2008, fueled by a meltdown in the housing market which spread to banks and the economy as a whole. There were many stories in the news about investors who panicked, sold off their investments at steep losses and subsequently ruined their retirement prospects. The market bottomed out in early March of 2009 and has been on a steep upward climb ever since, with a 290% gain in the index through the end of the first quarter of 2018. The losses in the stock market between 2000 and 2009 were the worst since the Great Depression.
These three events have several things in common: They were sudden and resulted in severe stock market declines over a relatively short time frame; all three had actual or potential impact well beyond the stock market; and in the case of Long Term Capital Management, the Fed stepped in to avert a potential systemic crisis. The financial crisis of 2008 had wide-ranging impacts throughout the financial system and the economy as a whole that are still being felt a decade later.
Stock market declines are common. Dating back to the Great Depression in 1929, there have been 10 significant bear market periods with an average decline of 45% and a duration of 25 months.
Talking to your clients
The financial crisis of 2008 seems to have had an especially profound impact on the thinking of many investors, particularly those nearing or in retirement. Many seem fearful of a repeat of some kind, especially in light of the duration of the market rally since early 2009. Many of your clients were probably fearful that the sharp declines in the stock market during the first quarter of 2018 signaled the start of another black swan type of event.
As a financial professional, it’s important to be the voice of reason for your clients in calming their fears and keeping them from sabotaging their financial futures. Fear can make clients do things that run contrary to their best financial interests.
Individual investors are notoriously ineffective at timing the market. Over the years, there have been a number of studies showing the cost of missing the 10 best days in the stock market over varying periods of time. One study shows that being out of the market on these 10 best days for the 20 years ending in 2014 would have resulted in an investment balance of roughly half the amount if the hypothetical investor had stayed fully invested. Missing the 50 best days resulted in a balance that was roughly 10% of what the investor would have had by being fully invested over this period.
For clients at or near retirement, it can be appealing to have a portion of their portfolio in cash or other low-risk liquid assets. This can better ensure your clients are able to meet their cash flow needs from their portfolio without having to sell the stocks in the fall of a declining market. But that safety comes with a price of limited or no growth potential. Clients have been historically forced to choose between growth or safety, but there are solutions available now that can address both. If appropriate for their situation, annuity products such as registered index-linked annuities offer participation in market-linked growth and a floor that limits downside loss could be considered for a portion of your clients’ portfolios.
For younger clients, financial professionals may need to hold their hands through periods of extreme market volatility, but it’s important that you stress the long-term nature of investing and financial planning. Losses can be hard to stomach even for younger clients, but by using statistics or studying market history, a benefit that you can provide these clients is preventing them from acting upon their own worst fears and instincts during periods of stock market upheaval.
Black swan events, as well as normal stock market corrections, will continue to happen. The world is changing and the pace of change in the markets seems to be accelerating.
The “old school” principles for dealing with stock market volatility remain the same. As their financial professional, it’s important for you to help keep your clients focused on their goals, their time horizon and their risk tolerance. Their investment portfolios should reflect these three critical factors regardless of their age.
1. Greenwald & Associates and The Diversified Services Group, Retiree Insights 2017: Survey of Consumers
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