Bradley K. Walton's Money’s Worth
Glass Half Full
Put the next market downturn in its proper perspective.
There’s a reason for all those client reviews you do: To monitor the progress you’re making in reaching your client’s most important financial goals. Having said that, while investment performance is an obvious topic for discussion, it shouldn’t be your only focus. Investment performance is relevant in its correlation to the client’s underlying financial plan.
Instead, for a review to be truly effective, you, as an advisor, need to predict your client’s questions and discuss account performance as it relates to appropriate benchmarks and planning assumptions. You need to assess their progress towards their long-term financial goals. What’s more, this review meeting is also your chance to learn about and discuss any changes in your client’s personal and financial situation that may make changing their overall financial plan a necessity.
It’s one thing to compare account performance to benchmarks; it’s quite another to compare it to the right benchmarks. If your purpose is to evaluate a specific manager’s performance, the benchmark should be narrowly defined, closely matching the manager’s specific category. On the other hand, if the purpose of the benchmark is to demonstrate the usefulness of an appropriately diversified portfolio, then a more straightforward benchmark, such as a simple “Stocks and Bonds” benchmark for different asset allocations, is what you need.
Remember, though, that benchmarked returns are all gross returns. In reality, reducing gross returns by 30 to 50 basis points is a more realistic comparison. For example, the Vanguard 500 fund trails the S&P 500 index due to the cost of doing business, the trading impact of bid-versus-asked pricing and the impact of holding cash. The only means for an investment product to equal or exceed the performance of its relevant benchmark is to somehow diverge from that benchmark in its investment strategy.
Never expect, or lead your clients to expect, continuous benchmark outperformance. It’s extremely likely that any and every portfolio will experience periods of under-performance, particularly when a widely defined benchmark incorporating relatively few indices is the point of comparison.
Instead, use your review meeting as an opportunity to remind your clients that markets and allocation strategies move through cycles. There will be periods of disappointing returns, and there will be periods of satisfying returns. Pointing out this fact when times are good lends this statement greater credibility. You don’t want your client to think you’re merely feeding him or her excuses.
Short-term wins and losses aside, the most important aspect of a client review is long-term financial progress. When seen in this light, those short-term losses, rather than gains, should be that much easier for your client to handle. It’s really all about perspective—and the ability to keep it.
Since it’s likely that the majority of your clients are currently holding allocated portfolios in gain positions, this is the ideal time to review financial plans and remind clients of the volatile nature of the securities markets. Doing this now will go a long way in enabling you to alleviate your clients’ concerns and anxieties during the next bear market.
Finally, remember that 2006 was the fourth consecutive year of positive returns for the broad equities indices. Historically speaking, we are due for a decline. It may not happen in 2007 or 2008, but it will happen at some point. Prepare yourselves—and your clients. 
About the author:
INSIGHT columnist Bradley K. Walton, CPA/CFP/CLU is a shareholder in Signature Advisers Group, Ltd. A graduate of the University of Illinois and former Elijah Watts Sells Award recipient, he is past chairman of the ICPAS Personal Financial Planning Committee and Personal Financial Planning Conference Task Force.