Why you need to remind clients that the past isn’t predictive

Why you need to remind clients that the past isn’t predictive

Damian Ornani, chief executive officer of Fisher Investments, explains why it's important that advisers talk to clients about the latest developments in markets.

Post By Damian Ornani

By Damian Ornani,
Fisher Investments

It is perhaps the most often-written sentence in investing: ‘Past performance is never an indication of future results.’

Lots of people tie this to disclosures on materials and relate it to an individual manager’s results. But it is bigger than that. It is a (perhaps legalistic) reminder: Markets aren’t serially correlated—past movement, recent or distant, doesn’t predict. Following a volatile, back-and-forth start to 2018, I suspect some of your clients need a reminder of this now, helping keep them on track toward their long-term goals and needs.

Nearly six months in, 2018 has been a choppy year generating meagre overall returns. The FTSE 100, for example, began 2018 with an equity market correction – a short, sudden, sentiment-driven drop exceeding 10 per cent. Between 12 January and 26 March, the FTSE 100 fell 10.5 per cent.

Moreover, in this year’s 113 trading days, the FTSE rose or fell by more than 1 per cent on 21 occasions, or once every 5.4 days. This is in sharp contrast to last year’s uncommon lack of volatility. Nothing approaching a correction occurred. Equities rose or fell by more than 1 per cent only 15 times all year! That is once every 16.8 days.

Last year, that smooth ride accompanied full-year returns of 11.9 per cent. This year’s bouncy trip? Through 13 June, shares are up 2.4 per cent year-to-date.

Given this backdrop, many clients may wonder if the volatility is worth it. Many likely see the past six months, feel the volatility acutely after last year’s calm, and extrapolate the tepid returns and big swings forward. This is natural, a behavioural tendency called ‘recency bias’. But it can lead to errors, like selling due to past market movement.

This tendency is also why many were hyper-bullish at the heights of the 1999-2000 technology boom, extrapolating fast-rising share prices into the future – failing to fathom the fact the direction could reverse. Similarly, in early 2009 – the depths of the bear market that accompanied the global financial crisis – the steep drops and huge negativity had few expecting anything positive for markets. What followed was a typically strong beginning to the bull market I believe presently continues.

Of course, today’s sentiment and market conditions don’t seem nearly as extreme as these examples. But given the choppy market and fears over Brexit, global interest rates, trade wars, a few problems in select emerging markets nations and more, it isn’t hard to see how clients could deviate from their retirement plan.

That is an opportunity for good advisers like you to help – a time to offer counsel, educate and prove your worth. Start by empathising. Make sure clients know you are on their side – and understand that this year feels markedly different than last. Then remind clients markets aren’t serially correlated – how this year began doesn’t mean that is its path forward. Use my two extreme examples, if you wish! Or use any of the equity market corrections during this bull market! Or find two of your own—there are countless.

But more importantly, remind clients with equity exposure why they have it in the first place. I doubt it has much to do with the coming six months. Nothing at all to do with the last six!

Equity investments, in my view, are all about harnessing long-term compound growth – what Albert Einstein famously called “the eighth wonder of the world” – to meet needs later in life. Clients in retirement may have 10, 20 or 30 years to fund! Missing positive returns – even a small amount like 10 per cent – can snowball due to compounding’s exponential impact. So do your clients a service –coach them not to let recent market movement affect their view of the future.

Of course, it is possible something has changed in a client’s goals or needs. You will have to explore that, too. But if you aren’t reminding your clients of the risk behavioural tendencies like recency bias pose to them achieving the results they want or need, I believe you aren’t serving them optimally.

Damian Ornani is chief executive officer of Fisher Investments. The views expressed above are his own and should not be taken as investment advice.

Add your comments

rayf

If the past isn't predictive, what is? It's the best we have, better than tossing a coin. OK, be careful.

Theo

The usual platitudes about the need to wait for the long term. What we are never told is how long that will be, or how long we should wait before deciding whether we are on or off target ''to achieve our long term goals and needs''. And why IFAs want to be paid in the short term.

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