Many advisors haven’t thought strategically about how to discuss performance with clients. We celebrate when portfolios outperform, but when relative performance is negative, we’re unsure what to do. Should we focus on the past periods of good performance? Do we try to look forward or point out other services we offer?
Hindsight Is a Powerful Force
In periods of underperformance or negative markets, many financial advisors aren’t sure what to say to their clients. The reason they find it difficult to discuss subpar performance is because they inadvertently trained clients to judge them on the portfolio’s results, even though the market’s performance is outside an advisor’s control.
What’s missing is an up-front conversation about how performance is only one part of the value an advisor offers. Without this discussion, clients see the advisor solely as a provider of positive portfolio returns—in either absolute or relative terms. This leaves clients vulnerable to the inevitable disappointments that come with investing. Emotions get amplified by hindsight. Investors feel angry and say, “How did you allow this to happen? You should have known better!”
Clients don’t realize that the advisors they hire are limited by two conditions: urgency and uncertainty. The condition of urgency requires advisors to deploy the investable assets immediately to preserve the time-value of money, while the condition of uncertainty means they can’t know the future trajectory of any investment or the outcome of the entire portfolio.
Inadequate Tools
Another part of the problem is that advisors often misunderstand the capabilities of their tools: research and diversification. Research, no matter how thorough, does not deliver certainty about the future. Research, while helpful and important, can only uncover meaningful information that may have correlated to positive performance in the past. Diversification protects a client from large losses, but also guarantees that the portfolio will underperform in some market conditions.
As a starting point for managing clients, it’s important to be clear about the limits of research and diversification. This helps clients understand what outcomes can rationally be expected.
Strategies for Avoiding Disappointment
The best way to prevent disappointment is to manage client expectations proactively. Several approaches can help. Some involve educating clients about an advisor’s role, while others relate to practice design and management. All the strategies are based on one key insight about human behavior: when clients feel threatened, they crave some kind of action, which may include finding a new advisor.
What can advisors do? First and foremost, listen to their clients and engage their rational brains. Start by accepting and recognizing clients’ disappointment and frustration. Reassure them that they’re being heard. Once an advisor has normalized the feelings, address the client’s expectation that you “should have known better.”
“No matter how much skill I bring to researching investments and diversifying the portfolio,” the advisor might say, “I still can’t predict the future. I know this limitation can be frustrating for you at times, and it is certainly frustrating for me. I want you to enjoy great returns, but that’s not something anyone can guarantee.”
Then review the value proposition of your business—the skills you have within your control: “I’d like to revisit the expectations you have of me and discuss the value of my services for you. Ideally, I’d like to come to a shared perspective with you.”
Once clients understand that their expectation of never suffering losses is irrational, it will be easier for them to resist those feelings. The next time the markets become volatile and the portfolio is down, the previous experience will inoculate clients from harboring unrealistic expectations.
Intervening proactively when markets are correcting and addressing irrational decision-making are important skills, but setting expectations ahead of time when markets are robust and clients are pleased is imperative. Introducing the expectation for occasional downside volatility when clients are feeling rewarded and secure prepares them for the future and prevents unreasonable expectations.
As counterintuitive as it sounds, the time to have the hard conversation is when things are going well. Advisors who address client expectations clearly from the outset will be better able to manage those expectations when markets are at their worst.