Living in a Financial Bubble

financial bubble

Having more than 30 years in the financial services business gives someone perspective. I remember vividly one of my friends and former co-workers calling me as he started his first day as a broker at Smith Barney on Oct. 19, 1987. I remember the euphoria of the late 90s and the tech bubble bursting in 2000. Frankly, the meltdown in 2008–2009 was the impetus and the foundation of this blog. As we are setting new records in the Dow and S&P, I think it makes sense to share some perspective, and more importantly, to share some best practices of some of the most successful advisors that I know.

History lesson level 100 class

In early 2000, SEI hosted a gathering of our large firms. The three-day annual event (this time held in Arizona) was a great mix of advisors from across the country and practice management sessions, and was highlighted by our Investment Management Unit’s market and economic updates and presentations by a collection of Institutional money managers (SEI acts as a manager of managers to our funds and separate accounts). Two of the manager presentations stood out: one was a small-cap growth manager who rode the tech and IPO market, and subsequently, had stellar performance; and the other, a highly respected CIO of a steadfast large-cap value manager, who didn’t play in tech or IPOs. Guess whose session had better attendance?

As the large-value CIO spoke about dot-com valuations that were unrealistic and the benefits of diversification, most of the audience didn’t listen. We were distracted by “the new paradigm” of investing. The internet was going to change everything and the fundamentals of investing were changing. Advisors, swayed by years of good-to-great performance, started to believe their own hype. Sure, they preached diversification, but with a wink, a nod and a “look how good we are doing” smile. Less than two months later that bubble burst.

History lesson level 200 class

In the spring of 2008, two experiences should have really tipped me off. First, I spoke at an industry meeting in the Midwest where the panel before me (a panel that conducted some industry “big shots”) debated a planning topic on whether to include a client’s home as an investment in planning assumptions for long-term capital appreciation and what multiples to assign to it. The idea was that most planners listed the home as a flat asset and didn’t account for the high appreciation rate in residential housing. By the looks and interaction with the crowd, they all thought it was an investment.

Later that day, I called my brother who is an attorney in Illinois. My brother relayed a story about a recent closing on a home where the buying couple was asked to come up with an additional $300 at closing on a $300,000 home—they didn’t have it. They were so leveraged buying a home—in what was only a cornfield three months before that—they couldn’t come up with 0.001% of the value of the home. We all know what happened in the fall of 2008.

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Not calling it

What intrigued me about the meeting in Arizona and interactions with advisors in 2007 was that professional advisors fell into the same traps as retail investors. I guess it’s human nature to get caught up in the hype. When an advisor is sitting across the desk from clients day after day, week after week, looking at their statements, and therefore, their net-worth go up, it’s easy to lose perspective. Why hear the realist large-value manager when I can hear the small-cap guy talk about his triple-digit return. Since the client keeps talking about how much their house value has gone up, maybe we should consider this in their retirement planning—selling it for three to five times will surely add to their retirement goals.

By no means am I calling the top of the market. I have no idea if this bull market will keep going a week, months, even a year or two more. What I do know is that the successful advisors that I knew (and know) use these good times to prepare their clients for upcoming volatility and financial markets “noise.”  More importantly, they are preparing themselves.

To do: Today

First of all, let me be honest. I was just as emotional as you and your clients. It was fun to look at the statements in early 2000 and 2007. It was a great feeling to think you’re on track to hit your goals and “richer” than you thought you would be at that point in your life. However, I also remember during the financial crisis having to spend my days on the road talking clients (and advisors) off the ledge and to stay invested. Truth be told, I believed what I was saying but there where nights (in some random hotel room) when I started to question if it would get better. And yes, of course it did.

What I learned coming out of both downturns was that communication as key preparation was essential. Advisors who regularly met with and communicated their value over and above the market performance were successful. Advisors who focused on planning and advice beyond investments were able to hold on to their clients. Moreover, those who acted like planners planned for their clients’ behavioral biases. Here are some of the actions and conversations that I see happening from those advisors today—things that you can do, too.

  • Today, start by writing out what you will do during the next downturn. How you will counsel clients, communicate with them and what they should expect from you? Print the document and distribute it to your staff, key stakeholders and family. Hold yourself accountable first.
  • Use the next meetings and next conversations to review and confirm your value proposition. The value prop should discuss a lot more than beating a benchmark or providing investment performance. Talk to them about your process and the long-term nature of their goals. Focus on planning and services.
  • Do a lifeboat drill with your clients using real dollar amounts and not percentages. Don’t ask what they would do/feel if the market dropped 15% on their $1 million portfolio. Ask them how they would react if the value dropped by $150,000.
  • Think about providing content (social media, blogs, newsletters, etc.) on topics about behavioral biases. Talk about the benefits of diversification.
  • Use your stories. When a client or prospect starts on the market or their returns, share your stories of the downturns. You are not calling the market either, but you are providing a balanced point of view. Don’t wink and take credit for the markets or you will be blamed for them as well.
  • Use this as a wakeup call. Start paying attention to what you say and how you act. What signals are you sending and what signals should you be sending?

Perspective is a wonderful thing. Our job is to help clients achieve their goals by providing sound advice, but clients have to be ready and open for the advice. They are open for advice the most when things are good and calm. Use this time to prepare and communicate, but remember to prepare yourself first.

Diversification may not protect against market risk.

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John Anderson

John Anderson

John Anderson is the creator and lead author of Practically Speaking blog and Managing Director of Practice Management Solutions for the SEI Advisor Network.

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