Executive Summary
One of the often-professed virtues of financial planning is that while we cannot necessarily completely prevent market declines from impacting client portfolios, at least when they do happen, “we have a plan.” Yet for too many financial planners, the reality is that the “plan” is nothing more than “we’ll keep doing exactly what we have been doing, and wait and hope for things to get better.” Well, if your only plan for dealing with a market decline is waiting it out in the hopes that things will recover in a timely manner, you don’t really have a plan; you just have a hope. A real plan takes more.
Today’s blog post is inspired by Dr. David Lazenby, who I wrote about in this blog a few weeks ago regarding his views on the importance of making the client planning process more interactive, as a way to make clients comfortable with, and have buy-in into, their financial plan. In an extension of Dr. Lazenby’s work at ScenarioNow, he also makes the point that part of planning – from the psychology perspective – should also involve “rehearsing” scenarios with clients.
What is rehearsing? The concept is relatively straightforward; instead of simply acknowledging that a market decline might occur in a client portfolio, actually go through the exploration with the client of how that scenario might be addressed. If there is a precipitous market decline and the portfolio takes a hit next year, what will you do? Will you alter your spending? Adjust your saving? Change your portfolio? Alter your retirement date? How will you feel when this is occurring? Are the tradeoffs you might face in a market decline concerning enough that it would be better to take a different path now?
Dr. Lazenby points out that the value of rehearsing is that when the bad stuff actually occurs, we can handle it in a much more rational and less emotionally tense manner, because it’s not longer a “surprise” anymore. We’ve rehearsed the scenario. We have already discussed what we would do in such a crisis. We know how to respond. Taking action is no longer a frantic scramble in the midst of an emotionally charged panic; it’s simply executing an action plan determined in advance.
But what strikes me about this exercise from Dr. Lazenby is not just his point about the psychological value of rehearsing scenarios to be able to manage them more effectively when the time comes; it’s that what you rehearse – the responses to a crisis – is itself ground that many planners do not cover very effectively. The focus is so often on “just stay the course” and wait (hope?) that markets recover. As many point out, they “always have” recovered eventually in the past; on the other hand, as the safe withdrawal rate research makes clear, markets that do recover still don’t necessarily do it in a timely enough manner to avoid a financial catastrophe. Market declines – even “temporary” ones – pose real risks for clients trying to achieve their goals.
Yet arguably, part of the planning process – in fact, what really makes it “a PLAN” – should include what CHANGES actually WOULD be made if the situation became concerning enough. If your portfolio experienced a sharp decline, the question is not: “Would you (A) sell in a panic, (B) stay the course, or (C) invest more because stocks are cheap.” Instead, the question is “If your portfolio experienced a sharp decline and you were concerned it might not recover in time, would you (A) spend less and save more now, (B) spend less in retirement so you don’t need as much in assets, or (C) delay your retirement date.” The latter constitutes a real plan about how to respond to an unexpected crisis; and notably, it is simply based on what you would do “if you were CONCERNED that the portfolio might not recover in time” – in other words, this is an exploration process based on anticipated client concerns and fears, not just something that gets executed once the client’s problems have gone so far that draconian austerity really is the only solution because hope alone didn’t work as anticipated. No, this doesn’t necessarily mean that you should have a plan to make changes to spending and retirement goals every time the market bounces up and down; but on the other hand, so many planners haven’t clearly identified with clients when action would be necessary in the face of a market decline, and consequently, almost by definition: there is no real plan, as there is nothing determine about what to do, when to do it, and how to execute it.
So what do you think? Is “staying the course and waiting [hoping] for the markets to recover” really a valid PLAN? Or is it only real planning if the process actually explores what changes would be made if there was a concern that the client’s goals might be in jeopardy? Do you ever “rehearse” scenarios of this nature with clients?
“If your portfolio experienced a sharp decline and you were concerned it might not recover in time, would you (A) spend less and save more now, (B) spend less in retirement so you don’t need as much in assets, or (C) delay your retirement date.”
Excellent replacement questions. Clients never really agree with any of those other choices anyway. These are REAL and meaningful questions. Another good line of questioning is to replace a % with a real $ amount that the portfolio drops, and ask how they feel about that now – it’s no longer 15%, it’s $150k or 2 years worth of spending – Are you sure you are still happy with “Portfolio C”?
A great area for investigation. Forget the slope of hope – it’s a pyhrric promise to clients. After all, do they need you if you do nothing to either prevent a decline or make an appropriate response if one should occur (and it will)? We got through the bear market in good shape, not because our portfolio values did not drop (they did) but because the income securities underlying client income continued to produce dividends and interest. In fact, we actually increased client income by raising some cash around the end of 2008 and deploying it again in March 2009. Buying lower meant increasing income, as we were able to produce more income with the same $$ by buying cheaper shares. But..are these portfolio acrobatics an acceptable line of defense for everyone? I doubt it, for they rely on making judgments about something wich can never be fully known (the future course of markets). This said, a solid risk management plan is preferable to simply watching, waiting and hoping.