rrc-blog-post-020314

Warren Buffett famously advised investors to be greedy when others are fearful, and fearful when others are greedy. Of course, the reason this strategy is so effective is that most of us are greedy when others are greedy. And as advisors conduct their annual reviews, they may be seeing some of that greed in their clients.

It’s been a while in coming. Even four years after the meltdown of 2008, most investors I spoke to were still jittery, and many remained on the sidelines “waiting for things to calm down.” Whatever glimmer of hope they enjoyed in the early recovery was snuffed out in 2011’s bear market, when Europe looked to be on the verge of economic collapse. It was common to hear young people—let alone retirees—say they would never invest in stocks again. By early 2013, however, I noticed the worm had turned. Now, following an extraordinary year for global markets, the memory of those dark months in 2008–09 seems to have faded into the distance.

In some ways, of course, annual meetings with clients may be a lot less stressful this year—at least for clients with significant equity holdings. But not everyone will be smiling as they look at their statements: conservative clients, including retirees who are drawing down their portfolios, may be questioning the idea of being heavily weighted in fixed income. And they may be voicing those concerns to their advisors.

Ready to take on more risk?

Consider the 70-year-old client who is heavily weighted in bonds and GICs. The DEX Universe Bond Index fell 1.2% in 2013, its first negative year of the new millennium. Investors expect stocks to outperform bonds, but last year the difference was downright painful. A GIC ladder wouldn’t have lost money, but that 2% return looks awfully meagre in a year where the MSCI All Country World Index returned almost 23%. Even the most disciplined retiree may be wondering whether she really needs to be so conservative. “I think I’m prepared to take on a little more risk,” she might say at her review. “Maybe we should consider 50% or 60% stocks instead of only 40%.”

We know most investors have a poor understanding of risk. Every advisor has seen risk tolerance questionnaires that express a desire for 7% to 8% returns while avoiding annual losses greater than 5%. Part of an advisor’s job is to manage unrealistic expectations like this: clients need to understand that even the most diversified equity portfolio can lose 40% or 50% in a matter of months. That was easy to do when 2008 was still fresh in everyone’s mind. It’s harder now, but it’s also more important than ever.

If clients are lobbying to add more equities to their portfolio, it’s time to remind them that risk cuts both ways. Retirees, in particular, often lack the time and the fortitude to deal with large drawdowns, and with capital preservation comes the expectation of more modest returns. When the pendulum once again swings from greedy to fearful, your clients will thank you.

Dan Bortolotti is an Investment Advisor with PWL Capital in Toronto. He is also a consulting editor at MoneySense magazine and the creator of the Canadian Couch Potato blog.
Originally published on Advisor.ca