Stock Volatility Need Not Drive Investors Away

    A headline which appeared on Bloomberg’s website yesterday “Stock Volatility to Leave Lasting Scars on Investors’ Psyche” highlights a concern that a growing number of investors are leaving stocks for good. Last week the S&P experienced an unprecedented four-day span of volatility in which the large-cap index fell and rose by at least 4% each day. In a panic, investors pulled $23.5 billion from US equity funds, the most since the financial crisis began in October 2008, according to the Investment Company Institute. 

Add the still-fresh memories of losses suffered following the Internet bubble of 2000, the 57% collapse in the S&P 500 Index from October 2007 to March 2009, and the one-day plunge in May 2010 that erased $862 billion in value from US shares in minutes and you have strong emotional reasons for avoiding stocks altogether. Laura Keeley of Bloomberg makes the case that many investors won’t return.

She points out that the $12.2 trillion mutual fund industry has historically been able to count on investors coming back to stocks following significant selloffs such as “Black Monday” in October 1987, the Asian currency crisis in 1997, and Russia’s debt default in 1998. She notes that in the year following the 2000-2002 bear market; US equity funds attracted $130 billion in new funds, according to the Investment Company Institute.

But the latest spate of power dives seems to have caused more than merely the loss of fund assets. Confidence and the willingness to take risk are evaporating. Keeley highlights ICI data showing that domestic stocks lost $98 billion in 33 straight weeks of withdrawals last year following the 20-minute market plunge in May. They’ve had redemptions of $74 billion so far this year. The latest withdrawal streak began in 2007 and didn’t end even as stocks surged from their March 2009 lows, according to Keeley.

We often hear burned investors proclaim that ‘cash is king.’ Keeley says that “cash holdings are at the highest levels since the record in March 2009, according to an Aug. 16 survey by Bank of America Merrill Lynch. Investors from 18 to 30 years old have the highest cash position of any age group at 30% of their portfolio, MFS Investment Management said in an Aug. 8 report. Almost three in five investors cite fear about volatility or needing money someday as a reason they hold high or increasing levels of cash.”

William Finnegan of MFS said “investors are in cash for a reason and, regardless of time horizon, conventional investing wisdom no longer applies. The Great Recession of 2008 has had a profound and longer-lasting impact on investors’ confidence than expected.”

With all due respect to Mr. Finnegan and the mutual fund industry, the Great Recession is less to blame for driving investors away from stocks than the fund industry themselves are; along with financial advisors who sell them without regard to their appropriateness relative to goals and resources. In short, too many investors are poorly advised. They are under-diversified and they take far more risk than is required to meet their important goals.  As a consequence, the volatility they experience is far greater than the broad stock market itself, and considerably more volatile than efficient portfolios designed with US Treasuries to hedge against stock market risk.   

Our Balanced Model is roughly 40% US Treasuries (7-10 year) and 60% stocks. Its volatility was only about a third that of the S&P 500’s. Our most conservative Risk Averse model (30% stocks and 70% Treasuries) was actually up .2% following the 4-day roller coaster ride.

It stands to reason that the less volatile one’s portfolio is, the more likely he or she is to remain calm and avoid emotional mistakes. During our planning sessions we encourage our clients to enjoy their lives more and worry less about the daily, weekly and monthly market gyrations. Through our patented Wealthcare process we can show them with assurance, the statistical probability of meeting all of their important goals.

While experiencing lower volatility than the stock markets and stock funds, our clients focus more importantly on their goals. When they ask us if they are OK, we understand that they are concerned about much more than losing money. Deep down, they need assurance that they are still on track to meet the challenges and goals ahead. They want and deserve more than an educated guess from us. That’s why we continually stress test their plans for proper funding to withstand the worst of markets. When we tell our clients they are ‘OK,’ we are confident in our assessment of their situation.

Following the 20% drop in stocks these last few weeks, we found that only 9% of our clients’ plans fell into an under-funded status. In each case, only modest adjustments were required to bring them back into our comfort zone. In each case the remedies were readily accepted by our clients because we had already discussed them according to priority. They changes ranged from eliminating the pre-payment of a mortgage for a couple of years, to delaying retirement by a year (they enjoyed their work) to increasing stock allocations modestly. The calls and adjustments were completed within a couple hours.

During all of last week we had only two incoming calls from clients concerned about the stock market and their plans. They and the clients we called went away more comfortable and confident in their plans and their investments, despite the media noise to the contrary.

The investment services industry bears much of the blame for the mess in which many investors find themselves. Clearly, if there were more fiduciaries and fewer salesmen in the industry, individual investors would be far better served and in much better shape. According to Wikipedia a fiduciary relationship exists when one person, in a position of vulnerability, justifiably reposes confidence, good faith, reliance and trust in another whose aid, advice or protection is sought in some matter. A client, according to Merriam-Webster is “one that is under the protection of another.”

How much better it is be protected as a client than it is to be sold as a customer. 

Have a nice weekend.