Your practice: No guts, no gains for anxious clients

Tue Nov 6, 2012 9:54am EST

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(Reuters) - Soaring equity markets have failed to lure skittish U.S. investors off the sidelines. That's left some financial advisers wondering whether they have an obligation to give them some courage.

The S&P 500 Index and Dow Jones Industrial Average are near the levels where they ended 2007. However, U.S. domestic equity mutual funds have seen $58.2 billion in outflows so far this year, while the safer haven of taxable bond funds has attracted $222.5 billion, according to data from Thomson Reuters' Lipper service. Meanwhile, investors are holding $8.66 trillion in checking, money market and other cash-like accounts, according to recent data from the Federal Reserve.

Many clients want to stay on the sidelines right now as they wait to see what happens with the U.S. elections and the pending "fiscal cliff". These people parked in cash may think they are preserving capital even if it means zero yield. But that's a mistake, say many wealth management experts. What they are failing to take into account: Inflation, currently contained, will steadily depreciate cash holdings if it rises.

"Doing nothing is actually a decision - and it can be a costly one," said Don Heberle, an executive director with BNY Mellon Wealth Management.

Advisers do not want to take clients too far out of their comfort zones, but they should educate them about the risks of avoiding equities.

SKITTISH CLIENTS

There are signs that advisers are not urging clients to move out of safe havens. Lipper's list of the top ten selling mutual funds this year is made up mostly of fixed-income and money-market funds, several of which are mainly purchased through advisers.

The Fidelity Institutional Money Market Portfolio, which is not open to retail investors, has attracted $7.8 billion this year, Lipper found. It's up 0.16 percent year-to-date. The S&P 500 is up about 13 percent.

Sometimes it's easier for advisers to sell people what they want to buy, rather than persuade them into a diversified portfolio that includes equities, said Scott Tiras, a Houston-based adviser with Ameriprise Financial. He said current fund flow data is concerning.

"It can't help but raise an eyebrow that some of us aren't doing our job," said Tiras, whose practice manages $1 billion in assets. He doesn't think these safe havens are bad investments, but he doesn't use them as a default for skittish clients.

EDUCATION FIRST

Many advisers say it's key to educate clients and then give them baby steps for coming off the sidelines.

New clients at Ballou Plum Wealth Advisors, a Lafayette, California-based firm that manages $210 million in client assets, have to study up before the firm allocates their money.

Marilyn Plum, director of portfolio management, spends about two hours on the process, showing clients historical charts of the markets, focusing on the period covering the tech bubble, the Great Recession to today. She also familiarizes clients with investing terminology and tax issues.

"We never want to be talking over (their) heads," she said.

James Herrell, director of investments for the Santa Barbara, California-based Partnervest Financial Group, uses the price of bread, which has doubled in the past five years in his area, to explain the loss of pricing power to cautious clients.

"Today you're either eating half a sandwich or you're dipping into your savings to buy that loaf of bread," he says, explaining that it is less risky to invest their money - even an ultra-safe fixed-income fund - because they will go from a negative real return to a positive return.

He often encourages such clients to move to conservative, fixed-income, exchanged-traded funds. They yield only around 2.25 percent, but can be a way to ease clients out of cash, Herrell said. Depending on their risk tolerance, he later moves them into something more aggressive, such as an equity ETF.

Ameriprise's Tiras has a similar strategy. He recently met a couple, prospective clients, who described their asset allocation as diversified because they had CDs in 10 banks.

Tiras, who has been on Barron's list of the top 100 U.S. financial advisers for eight years, told the couple that this wasn't diversification, joking that CD stands for "constantly depreciating".

After talking to them about their fears, Tiras recommended the couple move 35 percent of their portfolio into equity funds with a focus on large-cap, dividend-paying stocks. He suggested they make systematic buy orders over a six- to eight-month period to spread out volatility.

He showed them how such a portfolio would have performed in 2008 to give them an idea of the risk. The couple decided to wait to see the results of the elections before they decide.

Clients' bearish stance could prove prescient, as concerns about the elections, slowing growth in emerging markets and debt problems in Europe persist. But those worries must be balanced with inflation risks, advisers say.

"Inflation could get hot and it could happen very, very quickly," Tiras said.

(Reporting by Jennifer Hoyt Cummings in New York; Editing by Jennifer Merritt and Dale Hudson; Twitter @jenhoytcummings)

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