Walking Through Worst-Case

A seasoned CFP®, Stanley Ehrlich, recently wrote that financial advisors in practice for less than 8 years have never experienced a significant loss in the markets. Riding an upward wave, many of their clients might believe they can do no wrong. Ehrlich’s point was that now, at new market highs, is the time for such professionals to correct their clients’ misperceptions, before the markets do it for them.

Even though I have more than 8 years of experience (okay, nearly 4 times 8 years), it’s good to remember – markets will go down, significantly, several times over a normal person’s investing lifespan. How are you handling this fact of life? Here are some common strategies of professionals and investors alike:

  1. In meetings, a professional might show a portfolio’s worst history, but then gloss over it by saying something like, “But that was a once-in-a-lifetime event,” and move on, leaving the client to wonder briefly, “But if it did happen again, then what about me?” Rather than address this question, the professional focuses on the small likelihood of the occurrence.
  2. Some professionals believe they can predict market movements. They show backtested algorithms and spreadsheets proving their prowess. Research has shown repeatedly since the 1970s, these strategies can work well for a while. Until they don’t.
  3. Shiny Object. It has been hard to lose money in just about any market over the past eight years, so we have plenty of bright, shiny good news to focus on. We are all wired to believe recent history will continue, so, instead of thinking about the ugly scenarios of market corrections, it feels better to both advisors, and their clients, to look at the great results and just hang there.
  4. Finally, there are the (true) professionals who are willing to walk clients through the what-if’s of the worst-case. What if there is a “once-in-a-lifetime” correction again? Do they have enough cushion that no lifestyle adjustment would be needed? If not, how much of a lifestyle adjustment would it take to avoid selling in such a time? How far does the portfolio have to fall, and over what time period, before these kinds of questions must be entertained? What if there is not one correction, but more than one, over their remaining lifetime? What kinds of tradeoffs are options now in order to protect against those later? What if the correction isn’t the biggest risk, but inflation? Or a dementia diagnosis requiring years of long-term care? Not fun to think about, but necessary. Ironically, thoroughly thinking through the ugly future possibilities gives far more comfort to most people than being left to wonder, “What exactly is my worst case?”

Any advisor who leads or allows clients to believe future results will look like recent history, or that they can predict the timing of tops and bottoms, is headed for a cliff. Stick with those who are willing to look at the worst-case. I promise, at some point in an investing lifetime, any portfolio will go down, a lot. There’s nothing anyone can do to prevent that. But there are lots of things that can be done to prepare for it.

For more detail on how to evaluate your advisor’s approach, read Chapters 7 and 8 of The Mindful Money Mentality: How To Find Balance in Your Financial Future, or subscribe to our free award-winning monthly e-letter, “The View From the Porch” at https://www.hollydonaldsonfinancialplanner.com.

Holly Donaldson

Holly Donaldson, CFP® runs an hourly and fee-for-service financial planning practice virtually from her Tampa Bay, Florida office. She also works with clients throughout the U.S. (except Texas) interested in retirement and tax planning advice without product sales or investment management. Holly is the author of The Mindful Money Mentality: How to Find Balance in Your Financial Future (Porchview Publishing, 2013) and publisher of the award-winning monthly e-letter, "The View From the Porch."

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