Market volatility is par for the course in investing—yet it can still catch your clients off guard.
When markets dip or volatility prevails, investors often let their emotions rule, sparking feelings of anxiety (and even panic). This can lead to a premature sell-off, which can drastically reduce their returns in the long run.
Case in point: After the stock market dropped twice during the 2000s—and returned negative 50.9% at its lowest point—many investors lost confidence and opted to sell. Those that stayed the course, however, saw their strategy pay off when the market eventually rose, once again, and continued expanding for 93 consecutive months.
When you look at market trends dating back to the Great Depression, it’s clear this scenario wasn’t an anomaly. In fact, of the 80 overlapping 15- year periods from 1926 to 2019, none have resulted in a loss. Keep in mind, of course, that past performance is no guarantee of future results.
So how do you empower clients to keep a cool head while the markets plummet? Taking time to remind them of their long-term goals is unquestionably important, as is making sure their portfolio is adequately diversified. But preparing them for inevitable bouts of market volatility starts even earlier—when you help them establish a true understanding of the risk they can and should take on in their portfolio.
Investment Risk 101
For investors to feel confident weathering market volatility, they need to understand the difference between volatility and risk.
Volatility is a naturally-occurring part of the investment cycle—a degree of price variation that should be expected over time. Risk, on the other hand, describes the possibility of clients experiencing permanent losses, falling short of their investment goals, or realizing returns that don’t keep up with inflation.
Before they even build a portfolio, it’s consequently critical for your clients to have a firm grasp of the investment risks involved so they can clearly establish their preference and capacity for investment risk.
Finding the Sweet Spot
Most investors have an approximate idea of their personal risk preference. They understand different types of investments come with different levels of risk—and they’ve likely taken an assessment at some point to assess their personal tolerance based on their age, income, and financial goals. In most cases, however, personal risk preference is emotions-based and reflective of an individual’s tolerance for risk at a specific moment in time.
Risk capacity, on the other hand, is the amount of risk investors can actually take on, given their current life situation. It hinges less on emotions and more on numbers, and is calculated by taking their income and financial resources into account. It also identifies the amount of risk investors must take on to reach their financial goals.
Most portfolios are built on investors’ original risk preference—something that evolves and changes over time—while ignoring their risk capacity. This becomes problematic during periods of volatility because many investors’ foundational decisions, such as their portfolio mix, hinge on this emotional metric, with no firm numbers to back them up.
That’s why it’s important to both demonstrate your clients’ risk capacity and respect their personal risk tolerance to help them ride out market volatility.
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A Multi-Dimensional Questionnaire
At TIFIN Risk, our multi-dimensional questionnaire helps you get clients started on the right foot and keep them on track by taking short-term emotion out of the risk tolerance equation. By calculating and comparing three risk scores—risk capacity, risk preference, and portfolio risk—we provide you with an easy-to-use tool to demonstrate both where a client wants to be and where they have the capacity to be.
Beyond making it easier for clients to visualize their level of real portfolio risk during times of volatility, TIFIN Risk was designed to help you enhance portfolio compliance, offer a clear differentiator when prospecting, and strengthen client retention.
If you’d like to discover how TIFIN Risk can bolster your offerings, book a demo today.