Source/Contribution by : NJ Publications
During the market surge, they say:
- The markets are running, everybody is making money, I want to too.
- I want to invest for 5-6 months, I'll make quick money and exit when the markets start falling.
When the markets are pulling back, they say:
- My investments are falling, my money is vanishing, what have you done?
- You want me to invest when everybody else is withdrawing, I have already lost enough money, I don't want to invest more.
Often over our career, we witness such situations with our clients which leave us in a fix. We don't know whether to counter them and place ourselves in the detrimental spot, or give the client some space and let them follow their impulse. The latter is adverse for our practice, because the fundamental principle behind advising is “Protecting Client Interests”, which is the reason the profession exists.
The simplest solution to save yourself of the dilemma, and most importantly, help the investor stick to the basics is empowering them with investing wisdom, acquainting them with the basics.
Show the flipside first: Do not wait for the client to lose money, the flipside too should be presented at the start. Explain to them the risks associated with their investments. Like you shared the superior returns generated by Mutual Funds in the past, to make them believe in the product, it becomes equally important to familiarize them with the possible repercussions. Show to your clients the performance of the product during bearish markets also. Give a clear picture by showing the extravagant breakthrough received, followed by the steep blows faced by certain sectors like the IT Bubble bloom of the late 90's, followed by a smash in the face in the early 2000's.
Explain the concept of long term investing: You don't want to scare your clients with an unpleasant history, so you have to bring out the silver lining, which is: There is risk, but this risk can be calculated and controlled. The risk in Equity Mutual Funds is due to market volatility, which is short term in nature, certain events or news or a negative market sentiment can cause ripples, but over the long term this volatility gets neutralized, the ripples fade away, and the investments emerge to be stronger and bolder than ever. You have facts and data to substantiate your contention, markets have remained bearish in the past, as a result mutual funds have fallen too, but if you look at the long term data, they have rendered extraordinary gains to the investor, after proving for the bear market losses.
Risk Capacity: Many times people either underestimate or overestimate their risk taking capacity. It's important to gauge the client's Risk tolerance level, and ensure that his investment decisions fit into that level. There is a reason when the markets are rising and people are investing, but he isn't, it's because his risk profile doesn't allow him to, or this is the right time to invest in Equity, but his goal is a year away, so he should stay away. The investor should be acquainted with his Risk Tolerance level, so that his investment decisions are within his risk dimensions.
Set Reasonable Expectations: The best way to meet, rather exceed expectations is to trim them. Although, historically equity mutual funds have given superior returns, greater than 15% on an average, over long periods, greater than 10 years. But as they say, play it safe, you must tell your clients to expect around 13% return. The idea behind this conservative approach is when you overcommit, higher expectations are set, and when you are not able to perform to that level, it results in dissatisfaction. But when you keep a margin and the client's portfolio performs beyond his expectations, it yields contentment.
So, the bottomline is, for an investor to get impacted and react to a stimulus is natural, but if he is enlightened with the basics beforehand, the reaction won't be acute. Once the investors know how stuff works, it will help them take rational decisions during extreme situations, the knowledge will give you room to be able to convey your ideology of doing things right, during such situations.
