Although market volatility continues, history shows that equities are the best way for clients to earn the returns necessary to meet their goals, and advisors have an important role to play in convincing them of this, according to Marlena Lee, vice president of Austin, Tex.-based Dimensional Fund Advisors Ltd.
Speaking at the Institute of Advanced Financial Planners (IAFP) annual symposium in Vancouver on Thursday, Lee said that equity exposure – and global equity exposure, in particular – is critical for clients.
She pointed to historical data showing that in the past 112 years, the majority of the growth in wealth around the world has come from equities, even though sharp declines are a regular occurrence on global markets.
“Even though periods of drawdowns of 50% or more are actually quite common,” she said, “we’ve also seen that markets have rewarded this type of risk in the past.”
Many investors, rattled by the financial crisis and the extreme market swings in recent years, are likely tempted to give up on stock markets, Lee said. In fact, she said many exited the market at the worst possible time, when stocks hit their low point in 2009. As a result, they failed to participate in the recovery that followed, and are thus going to have a harder time reaching their investment goals.
“Left to their own devices, investors make very bad decisions when it comes to handling market volatility,” Lee said. “The biggest challenge I think that investors face is really being disciplined, taking care of their own emotions, and not jumping out of the markets at the very worst time possible.”
This is where financial advisors have a critical role to play, Lee added. She said advisors must remind their clients that just as there are risks associated with investing in equities, there are also risks associated with seemingly safe vehicles.
“People tend to be really focused on one type of risk, and that’s volatility risk,” she said.
Holding large proportions of cash or other low-yielding securities, however, could put clients at risk of failing to meet their longer-term investment goals, Lee said.
“If you are viewing risk through the lens of how likely am I going to be able to meet my investment goals? Am I going to outlive my portfolio? In terms of that type of risk, equities can be considered actually far less risky, because they have a high expected real return associated with them.”
With global interest rates at historically low levels, Lee added, this type of risk is particularly relevant today. She said low interest rates have resulted in yields so low that in some countries, they’re not enough to compensate for inflation.
And, she expects rates to remain low for the foreseeable future. “There is a chance that we may be here for a while,” she said.
For clients who are unwilling to take on equity market risk, Lee said advisors may have to have frank discussions about the need for them to reduce their spending in order to meet their goals.