The events of 2008 damaged investor confidence and trust in two important respects.

First, many clients experienced erosion in the confidence and trust they have in their advisors and financial institutions.

Second, many clients have become dubious about the long-term merits of investing in the stock market.

After the “tech wreck” in the early part of this decade, many Canadians took a skeptical view of high-tech stocks generally and of start-ups particularly. Today, many Canadians are looking skeptically at all stocks.

At a certain level, given last year’s dramatic decline, the unravelling of global financial services institutions and the continued market turmoil, this is understandable. But, at the same time, shying away from investing in equities will make it impossible for many Canadians to achieve their long-term goals.

In such cases, the primary job of advisors will be to help their clients understand the implications of their actions — and to help them regain confidence that equities markets are good places to be.

Here are six elements of a conversation you could have with clients to achieve that:



> Start By Addressing “Soft” Issues.

Having a productive conversation about markets often means starting with your client’s emotional response to the decline in his or her portfolio. Until you deal with these “soft” issues, you can’t get your client to focus on the hard issues related to his or her plan and portfolio.

So, start by saying something like this: “Many people lost sleep as a result of the markets this past fall. How did last fall’s market affect you?”

Having asked the question, sit back and really listen; hear your client out. The time you spend on this first stage is essential to getting your client to feel that someone is listening to him or her.

And let your clients know that you understand how tough they have found this environment — and that you’ve found it difficult, too. Clients want to feel that their advisor empathizes with their situation.



> Go Back To Clients’ Objectives.

The next stage is to revisit your client’s objectives and the plan that is in place to achieve those objectives.

If your client can hit his or her long-term goals with a return of 4% or 5%, then staying away from stocks may be a rational response. But the hard reality is that most clients will need a significantly better return than 4% or 5% if they are to retire when and how they want.

Take the time to demonstrate the implications of lower returns — the need to save more, work longer or scale back on the standard of living after retirement (and, in some cases, all of the above).

The essence of a financial plan is about clarifying the trade-offs that clients have to make. So, you can say to your clients: “There’s no question we can reduce or even eliminate our exposure to stocks if that’s what you really want. But let’s take a look at the possible implications of doing that.”



> Point Out The Extent To Which 2008 Was An Aberration.

Last year’s decline was one of the most extreme on record. You have to go back to the 1930s to find an equivalent drop in market value. You might want to start by walking your clients through one of the easily available charts — which can be obtained from many mutual fund companies — that show the distribution of long-term returns.

Going back to 1925, these charts show U.S. large-cap stocks had an average annual compound return of 9.5% and made money in 70% of those years. The average annual real return after inflation was 6.5%. Canadian numbers tell a similar story. The S&P/TSX composite index had an average annual return of 7% in that period, and reported positive results in 67% of those years. These charts also show just how unusual last year was.

In some instances, you should be prepared for a skeptical response — some particularly cynical clients will view these charts with a jaundiced eye, seeing them as a “sales pitch” on the part of their advisor.

For those cynical clients, avoid charts that carry the logo of a money manager or fund company, as these will be red flags.



> Talk About Today’s Opportunities.

The next step is to discuss the opportunities that exist in today’s market.

@page_break@Given all of today’s bad news and dire headlines and the unpredictability of markets in the immediate period ahead, discussing opportunities effectively means focusing on the medium term — that is, two to five years from now. As a general rule, stay away from discussions about long-term prospects; clients today may see the phrase “long term” as a cop-out and an abdication of responsibility on your part.

There are two ways in which to make the case for medium-term opportunities. One is to have a macro, top-down conversation in which you discuss market valuations and price/earnings multiples.

This approach may work in some cases, but will not be persuasive in all cases. It will, of course, depend on whether your client understands P/E multiples. Additionally, when you focus on valuations, there’s a risk your client might say: “It’s fine to talk about stocks today being at 10 times earnings. But I was reading online that during market troughs the P/E can be as low as six times earnings. Why not wait?”

The final difficulty is that having a rational conversation about valuations doesn’t address the real issue for many clients: their fear and emotional response to last year’s traumatic events.

A better approach might be to focus on individual stocks with which clients are familiar. Consider companies such as Shoppers Drug Mart Inc., McDonald’s Corp., Wal-Mart Stores Inc., Microsoft Corp., Procter & Gamble Co. or Imperial Oil Ltd.

These are all household names for which you can make a compelling medium-term case, even with all the uncertainty facing us, whether it be as an individual stock or as a top holding in a mutual fund that you are recommending.

In today’s environment, a bottom-up, company-specific conversation will often engage and reassure clients in a way that top-down, valuation-focused conversations won’t.

But if you do want to have a macro conversation about market opportunities, consider focusing on just the “E” in P/E multiples and talk about the link between corporate profits and stock prices. In many cases, your clients aren’t clear on the concept that what really drives the stock market over time is growth in corporate earnings.

So, show your clients a chart demonstrating the growth in earnings for stocks in the S&P 500 and the S&P/TSX indices — with dips during recessions, but also with a steady uphill climb over time.

Talk about your confidence that we will work through this, as we have all past recessions — and that a resurgence in corporate earnings down the road will see stock prices advance once again.



> Address The Possibility Of A Protracted Downturn.

Many clients are spooked by all the bad economic news in the newspapers, the possibility of an extended downturn and the talk of another depression.

You can’t dismiss this entirely — but you do need to put the likelihood of this scenario into perspective.

Start by pointing out the three important lessons the U.S. learned from the 1930s: the need to keep financial institutions solvent so that consumers don’t lose confidence in banks; the need to create fiscal stimulus through government spending in tough times; and the need to avoid the protectionist tendency to raise trade barriers.

You can also point to the very low odds of a true depression, in which economic output declines by 20%. To put it in perspective, note that from 1929 to 1932, the U.S. economy fell by 30% and the Canadian economy lost more than 40%.

In a recent Wall Street Journal article, Harvard economist Robert Barro described his in-depth study of 251 stock-market declines and 97 cases in which the economy declined by 10% or more, going back to the 1800s. He covered 34 countries and concluded that the chances of a severe economic contraction of 10% in the U.S. are one in five and of a depression-like decline of 20% are one in 50.

In light of that, you can say to your clients: “We will very closely monitor the economic outlook for any signs that we are experiencing a dramatic decline in the economy; if that happens, we’ll certainly adjust your portfolio. In the meantime, we need to plan for the 80% chance of a normal recession rather than the 20% chance of a more pronounced contraction or the 2% chance of a depression.”



> Discuss The Best Way To Re-enter Markets.

It’s always important to talk about the possibility of markets declining in the short term, and that’s especially true today.

If your clients buy into your argument, you need to have a discussion about how impossible it is to predict short-term market fluctuations. You can point to one of the charts showing how markets have bounced back after the kinds of declines we saw last year, but you also need to acknowledge the possibility of continued tough times in the immediate period ahead.

In light of that, you need to talk about how to enter markets. In some cases, your clients will be prepared to commit fully now. In others, they may want to wait until there are clear signs of a market recovery, and be willing to give up a gain of 20% or more to do that. (The bigger problem with waiting for a run-up before re-entering the market is that markets never move up in a straight line; a 20% gain can be immediately followed by a 10% pullback.)

For many of your clients, the best solution might be a staged approach, investing in increments over a period of 12 or 18 months. This conversation won’t always be an easy one. In some cases, rebuilding confidence that markets will be a good place to be in the long term will be a tough task, requiring repeated discussions.

Just because a conversation is difficult, however, doesn’t mean that it doesn’t need to take place. In many cases, this is the most important message that Canadians need to hear from their financial advisors today. It is one way that you can prove your worth and deliver real value to your clients. IE



Dan Richards is president of Strategic Imperatives Corp. in Toronto. For other columns and to access Dan’s blog, go to
www.investmentexecutive.com.