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In good times, advisors go to great lengths to remind clients that the party won\u2019t last, and to tease out how clients will feel when portfolios lose 20% of their value.<\/p>\n
\u201cComplacency can set in,\u201d says Darcie Crowe, investment advisor and portfolio manager at Canaccord Genuity Wealth Management in Vancouver, describing the \u201cgreed phase\u201d of the market after a decade-long bull run.<\/p>\n
\u201cInvestors push beyond what their true risk tolerance and comfort level is because of the fear of missing out,\u201d she says.<\/p>\n
Advisors have various methods to push back, but none as visceral as the real thing. In that sense, the economic fallout from Covid-19 presents a rare opportunity to review clients\u2019 risk tolerance.<\/p>\n
\u201cNow people really know their feelings,\u201d says Blair Corkum, a fee-based financial planner who runs Blair Corkum Financial Planning Inc. in Charlottetown, P.E.I. \u201cWe all know how brave we are when times are good.\u201d<\/p>\n
Understanding how clients feel during drastic market movements will help avoid situations where a client who\u2019s outside their comfort zone insists on selling in a market trough, Crowe says.<\/p>\n
\u201cThe only way you\u2019re going to be able to do that is to have these honest conversations about risk tolerance when they\u2019re actually in that period of distress \u2014 to paint that more realistic picture about how they feel,\u201d she says.<\/p>\n
There are also urgent, practical reasons for reviewing know-your-client information now. In addition to portfolios suffering as markets tanked in March, clients may have lost their jobs or become ill during the pandemic. Such changes could significantly affect clients\u2019 retirement goals, time horizons and risk tolerance if cash is needed immediately to make up for lost income or another emergency.<\/p>\n
\u201cThis economic shutdown has been so extreme that there are material changes for a lot of clients and it\u2019s the advisor\u2019s job to uncover those changes and be aware of them,\u201d Crowe says.<\/p>\n
She has a client in the hospitality sector for whom it could take years before income returns to pre-crisis levels, so she may need to make portfolio changes to accommodate income requirements and adjust the client\u2019s retirement plan.<\/p>\n
As urgent as those conversations are, there\u2019s a downside to adjusting risk tolerance at such a vulnerable time, says David Lewis, chief client officer at behavioural economics consultancy BEworks in Toronto.<\/p>\n
Most clients are feeling anxious and prone to a \u201cscarcity mindset,\u201d Lewis says \u2014 prioritizing immediate needs over future ones; focusing on past losses rather than potential gains \u2014 and less capable of rational thought.<\/p>\n
As a result, clients will be much more risk averse than normal, he says.<\/p>\n
\u201cClients who\u2019ve had a significant change in circumstances where their risk preference should go down or should go up \u2014 that\u2019s a great time to have that risk preference conversation,\u201d he says.<\/p>\n
\u201cBut the advisor should also be cognizant of the fact that everyone\u2019s risk preference will have shifted downward to the global pandemic context. In some cases, that may not be realistic.\u201d<\/p>\n
For example: a client who wants 10% returns without any risk. The advisor\u2019s value, Lewis says, is being able to explain the trade-offs between low-risk investments and retirement goals, and putting market crashes in context.<\/p>\n
If a client\u2019s panicking now, Corkum says, it could be because their risk profile wasn\u2019t quite right.<\/p>\n
\u201cThe real-life feelings are there now to discuss,\u201d he says.<\/p>\n
\u201cIf they\u2019re saying they can\u2019t sleep at night, we need to modify that profile.\u201d<\/p>\n
Timing is important. While taking a client\u2019s concerns seriously, advisors still need to avoid selling off risk assets in a downturn.<\/p>\n
\u201cWhile we need to tone [clients] down when they\u2019re in euphoria, we need to build them up when they\u2019re panicked,\u201d Corkum says.<\/p>\n
Advisors can help clients manage their liquidity needs and put off the broader risk discussion for a less emotional time.<\/p>\n
A few months from now, when markets have (hopefully) recovered, advisors can refer back to how clients felt during the downturn and look at restructuring the portfolio then, he says.<\/p>\n