With the stock market still riding high in a bull market1 — the Dow Jones Index broke 20,000 for the first time in late January, and has hovered around the mark ever since — advisors can find themselves in a bind. Timing the market is widely regarded as impossible, but no one wants a client to be over-exposed to equities when the bears take over.

At the same time, clients are enjoying the ride. The memory of the 2007-2008 financial crisis and the havoc it wrought on the stock market hasn’t faded entirely, but strong stock markets can be particularly alluring.

“It’s a good time to level-set and have a conversation with clients about risk tolerance,” according to Chad Smith, a wealth management strategist at HD Vest Financial Services.

Hedging strategies

There are, of course, mechanisms to hedge against a sudden drop in stock prices. Those include buying puts on index-based securities, whose value moves in an inverse relationship to the basket of stocks represented in the chosen index. There is also the “inverse ETF,” also known as a “short ETF” or a “bear ETF.”

Moving into that territory could, however, require a lot more sophistication on the part of clients who have never had a direct stake in securities that effectively short the market. And there is no pure “heads I win, tails I win” strategy, of course.

A more tempting line of argument to a client from an advisor with a tax and accounting background might be to stress the value of harvesting some long-term capital gains (in taxable accounts), given their low rate of taxation, and the possibility of having those liabilities erased if capital losses are incurred and recognized later in the year. However, “You need to be careful about letting the ‘tax horse’ drive the cart,” Smith warned.

Instead, he recommends that advisors sit down with clients – sooner, rather than later -- to revisit the financial goals they articulated at the most recent goal-setting meeting. The conversation should also reprise the original discussion of the client’s risk tolerance, as measured by the amount of volatility and/or loss they can comfortably accept.

If that original conversation was inconclusive or never took place, there is even greater urgency about having it now.

Asset allocation discussion

A discussion of financial goals should lead to determining a benchmark asset allocation. The easiest conversation with a client today is about rebalancing the client’s portfolios. “If the goal was a 60/40 stock/bond allocation and that’s where the client was even a year ago, the actual allocation today will be way out of line,” Smith said.

“If the client is reluctant to lighten up on equities, the discussion turns to, ‘Have your goals changed?’” he added.

In any important conversation with clients about investments and other facets of financial planning, it’s a good idea to summarize the conclusions of that conversation, send it to the client, and request a response indicating whether it accurately captures the client’s wishes. That will carry more weight than a simple recitation of notes from a meeting that took place months ago if the consequences of a client’s direction are not to his liking, and he points the finger at you.

What happens to the proceeds of unwinding some stock positions? For clients who don’t want to keep it in cash or move it to low-yielding bonds, an alternative has been gaining some popularity. “We’re seeing a lot of ‘mass affluent’ clients buying variable and index-linked annuities with multi-year guarantees,” Smith said.

Some are better than others, and which is which isn’t always easy to determine. Among other reasons, that’s because various categories of embedded expense, such as provisions for mortality risk, distribution and simple overhead costs, are hard to separate.

This is an example of where an advisor with the analytical skills that accompany an accounting background can really add value to a client relationship. The same holds true with respect to the larger task of keeping clients from letting emotion overpower reason in basic investment decisions, according to Smith.

1Dow Jones Industrial Average, CNN Money 2017


Published in partnership with HD Vest

For more information about HD Vest Financial Services and how they can help you transfer a client’s wealth, visit hdvest.com/join or contact a Business Development Consultant at (800) 742-7950. HD Vest Financial Services® and its affiliates (collectively, “H.D. Vest, Inc.”) do not provide tax or accounting services. You should consult your tax professional regarding the tax implications of any investments. The views and opinions presented in this article are those of Chad Smith and not of HD Vest Financial Services® or its subsidiaries. Asset allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses. HD Vest Financial Services® is the holding company for the group of companies providing financial services under the HD Vest name. Securities offered through HD Vest Investment ServicesSM, Member SIPC, Advisory services offered through HD Vest Advisory ServicesSM, 6333 N. State Highway 161, Fourth Floor, Irving, TX 75038, 972-870-6000.