Handling the Ups and Downs
Helping your clients handle market volatility
Volatility isn’t new to markets, and is something that will accompany investing forever. There have always been times in markets when, in the words of famous economist John Maynard Keynes, “Markets can remain irrational for a lot longer than investors can stay solvent.”
By definition, volatility is the trait of being unpredictable. In the investment world, it is a measure of the dispersion of returns for a given security or index. Volatility can either be measured by using the standard deviation or variance between returns from that same security or market index. If you are a CFA or a CFA candidate, you learned how to calculate volatility and understand exactly how it is determined for a specific security. For the rest of us, we can rely on the myriad tools available to research the volatility of either a specific holding or a portfolio in total.
The clearest example that I can give you is how clients react to new headlines about the major indices here in the U.S., such as the S&P 500 index. When the headlines are strong and the S&P is performing well, all clients want their portfolios to perform as well as that index. But when that index turns south, as it did in 2008, your clients may expect that they will not bear the brunt of the losses, even though those losses may be predictable and consistent over a long period of time because of the volatility inherent within that basket of 500 large-capitalization common stocks. Of course, the challenge is to know when that negative volatility is about to occur and what to do about it. Some argue that this is impossible and others have created strategies or tactics to attempt to mitigate volatility.
Either way, the best thing you can do early in any client relationship is to educate them about volatility. Help set their expectations about the historical range of outcomes for their portfolio or any particular holding.
WHAT TO SAY
First, this will let them know volatility will happen, and when it does, that this is a normal part of investing. Second, it will assist with designing a portfolio that may limit volatility by including less volatile asset classes (such as cash) and lower their expectations for both volatility and ultimate performance.
As witnessed in the summer of 2015, as soon as markets get jittery, clients who understand volatility and those who do not may begin to freak out. You get calls and e-mails and you may wonder what next to do. Read more on Accounting Today.