Does your financial advisor have a plan to deal with market risk?
I have several acquaintances who are in the financial industry. Most are friendly, honest and sincere. I would trust them to take care of my children anytime. However, I would not allow them to manage my investment assets. That’s because they have been trained in the culture of Modern Portfolio Theory (MPT). In other words, they believe that diversification alone is sufficient protection from market risk.
The combination of market downturns that began in 2001 and in 2007 finally prompted many economists and financial experts to admit that MPT does not work. In past commentaries, we have highlighted numerous quotes and comments from such people. http://www.marketowl.com/2009/03/26/proponents-of-buy-and-hold-are-disappearing-fast/ In spite of agreement among these experts that MPT is flawed, most of the local financial professionals I know stubbornly cling to the idea that asset allocation and buy-and-hold investing is valid. I suspect that is because they do not have any other method to offer.
Unfortunately, by sticking to methods that don’t work, they are risking the financial futures of their clients. It’s kind of like a local physician 150 years ago who continues to bleed his patients in an attempt to cure them because he doesn’t understand recent discoveries linking illnesses to viruses and bacteria.
Given the volatility and performance history of the financial markets over the past decade, there are some important questions that investors who use the services of a professional advisor should consider. These are especially critical for investors who are nearing or at retirement age.
1. If you use the services of a financial advisors, does that person provide competent advice and service?
2. Has he or she explained how your investment assets are protected against market risk?
3. Do you think something or anything could have been done to protect your assets from losses that might have occurred?
4. If you thought there might be another 40% market downturn sometime in the next four or five years, do you trust your advisor to protect your investments from possible double-digit losses?
The recent stock market rally has caused many investors (and advisors) to breathe a sigh of relief and to believe that stocks are making another long-term bull market run. And while I do not profess to be able to predict what the market will do, it seems prudent to assume that there could be significant market corrections still to come. It might be several years before we see another major decline or it could occur next month.
The important question investors must answer is whether they have a plan for effectively dealing with the next major downturn, whenever that might be. And investors who are paying a financial professional to manage their portfolios need to ask their advisors about their plans for dealing with market risk.
As the chart above shows, in the past decade there have already been two powerful bear markets. Major indices are currently at about the same levels as they were 11 years ago.
Given the current economic situation, it seems likely that major swings in the market are likely to continue into the future. All investors, but especially those who are near or at retirement age, need to carefully consider how they can protect their investment assets from future market downturns.
F.S.