The financial planner's conundrum

The current global economic uncertainty has resulted in many investors questioning the wisdom of some of their investment decisions. Michael Carrigan explores ways in which financial planners can prepare their clients for the new economic environment.

Many years ago, a fund manger produced a small publication titled “Greed, fear and the psychology of sharemarket investing”. It's comments are as true now as they were then.

In essence, it noted that in ‘good times’, investors follow newspaper hype and the lead of others as though there is no tomorrow, and keep investing without having regard to the fundamentals of the stock market generally, or the stock in which they are investing.

Conversely, in bad times, the same investors are prone to panic selling – again, forgetting to consider the fundamentals.

One of the critical tenets of financial planning is that planners should educate and ‘condition’ their clients to understand that investing is not one-way traffic.

In other words, stocks will rise and fall, depending upon the economic cycle and other factors. In most cases where a financial planner has correctly assessed an investor’s tolerance for risk, the investor is less likely to react to short-term ‘dips’ in his investment portfolio.

The current global economic uncertainty, however, is causing even those who would otherwise be quite comfortable with the investment decisions they have made to now question the advisability of some of those investments. This is particularly so, where investors are approaching retirement only to see the paper value of their retirement savings shrinking at an alarming rate.

Few would deny that stock markets throughout the world are experiencing unprecedented levels of market volatility. It is this volatility that is causing even the most experienced of investors to doubt some of their prior investment decisions.

More than ever, financial planners have a critical role to play in steering their clients through the mire.

One of the issues a financial planner needs to ask is how confident can we be that the current state of the world economy is anything more than a short-term ‘bump’.

This is a particularly difficult issue to reconcile at a time when world leaders (particularly in the Eurozone and the USA) seem to be either unable or unwilling to make the hard decisions.

Despite the risks, the perception (from a planner’s viewpoint) is that many politicians are still inclined to place a higher value on short-term political expediency than national, and for that matter, international interests.

Another issue is that when the global financial crisis first took hold in 2008, governments chose to bail out financial institutions which it was believed were too large to fail. In consequence, excessive private bank debt (brought on by ‘cheap’ money and lax banking regulations) was replaced by public debt.

Even here in Australia, where we have one of the better performing economies in the Western world, government policies have had a tendency recently to rely on borrowing (deficit financing).

A further thing that must be borne in mind is that should world leaders be unable to resolve the current crisis in the financial markets, there is a real danger of much of the developed world falling back into recession.

Such an outcome could lead to a softening in demand for commodities and this, in turn, could have a direct impact on the current backbone of the Australian economy – mining.

In other words, while Australia to date has managed to escape the worst of the economic downturn, it is not immune from negative external developments.

The challenge facing many governments, particularly in the Eurozone, is to find a means to finance their debts. Readers would be aware that major austerity programs have been introduced by many governments, including those of Greece, Ireland and Italy in an attempt to stave off default.

The conundrum, however, is that these austerity measures themselves can create further downward pressure on an economy by reducing a country’s capacity for growth.

Having regard to the preceding comments, today’s financial planner has some difficult challenges. Is it “business as usual”, or having regard to the current economic circumstances, is it more appropriate to adopt a more conservative approach in the investment recommendations made to clients?

For the longer term investor (at least five to seven years) the current economic uncertainties should offer significant upside opportunities, as and when economic conditions return to something approaching normality.

However, even for the long-term investor, now is not the time (in this financial planner’s view) for investment in highly speculative ventures, as these are simply too risky. Using proven processes and strategies, a financial planner should be alerting clients to both the risks and opportunities that currently exist in the market. It’s business as usual.

For investors in or approaching retirement, the challenge is more difficult, as unlike the longer term investor still earning a regular income, time may not be on their side. The length of the current economic malaise is such that many of these investors have used up all or a large portion of the cash buffer which most financial planners will have built into their portfolio.

The challenge facing financial planners and their clients is deciding what investments should be liquidated to provide cashflow, and what should be retained. This financial planner is finding that many retirees simply want to cut their losses and get out. Fear has overwhelmed them.

In these situations, it’s still business as usual managing client needs and expectations, but with an extra touch of caution.

Michael Carrigan is an authorised representative of Fiducian Financial Services.