Covid-19 Crisis: Four Lessons For Financial Advisors
Bill Gates once famously said that “success is a lousy teacher, as It seduces smart people into thinking they can't lose”. Such is invariably the case with those working as Financial Advisors. When the tailwinds are strong, many an Advisor has been lulled into the mistaken belief that they are infallible geniuses at work – but as anyone who survived the aftermath of 2008 will testify that this is more often than not far from true. As the COVID-19 crisis melts down Financial Markets across the world, it’s as good a time as ever for Advisors to reflect on the key lessons that they can glean from this experience. Here are a few.
Always be clear about risks
Investors tend to have short-term memories; and to make matters worse, their optimism waxes and wanes in direct proportion to market movements. This means that their bullishness on any given asset class would be reaching heady heights just as they approach peak valuations. That is just one of the reasons why it’s critical to clearly explain the risks associated with every investment, however ‘theoretical’ those risks might seem. Take for instance how debt funds have fared over the past couple of years. Credit defaults and yield spikes have marred their returns, pushing many of them into negative territory even! And yet, they would have been touted as risk-free alternatives to FD’s by most Advisors. Before facilitating an investment, it would be very prudent to have a signed statement of risk in place, which clearly delineates that your client has understood parameters like volatility, worst quarter/month/year returns associated with a given investment.
Asset allocation never goes out of style
The time-tested process of building out a portfolio in a top down manner, after completing a thorough assessment of an investor’s risk tolerance, never goes out of style. Of late, with the widespread proliferation of Systematic Investment Plans, it’s not uncommon for investors to be 100% invested into equities at all times, regardless of their risk profiles or market valuations. While SIP’s can serve as an efficient means of funnelling fresh moneys into equities, it doesn’t take away from the criticality of an annual or bi-annual rebalancing exercise that would bring the accumulated portfolio into sync with the investor’s risk appetite. The “SIP it, shut it, forget it” platitude doesn’t work in theory. You need to be proactive with your regular rebalancing exercises.
Understand that Mean reversion is an inevitability – just the trigger is different
It’s all too common to be seduced by the four words that Sir John Templeton proclaimed as the four most dangerous words in investing: “This time it’s different”. The fact is, it’s never really different. Irrational price upswings never last long (look at Real Estate which has been languishing since 2012 after a bumper half decade). Even recently, we saw frontline stocks rallying or not breaking down despite subpar earnings growth, resulting in stretched valuations for many blue-chip stocks. As always, they reverted to their mean - the COVID-19 crisis was just the trigger. Analysts and so-called experts will always find a way to justify why this time, overvalued assets will not correct; however, they invariably do. As Advisors, it’s important that we use our common sense and always keep the above in mind while designing portfolios.
Never call a bottom… or a top
This month’s blitzkrieg on the equity markets would have served to reinforce the fact that it is quite impossible to call a market top or bottom. When panic or euphoria take over, all sophisticated charting tools and projection models fail miserably. Who would have projected that the bellwether NIFTY index would have fallen more than 40% from its peak in a matter of less than a month? As Advisors, it’s very important to not fall into the trap of projecting that markets have bottomed out or topped out. Use prudence and common sense to stagger moneys in and out of equities instead of adopting an “all in” or “all out” strategy – that is guaranteed to backfire.
