While a financial plan provides a technical framework for managing your financial life, the biggest benefits may come from the non-technical aspects delivered by your planner – including setting expectations and helping you navigate the inevitable emotional peaks and troughs.
When share markets are booming, investors’ appetites for risk can become insatiable. They have little interest in discussing the possibility of prices going into reverse. Likewise, when markets head south, they see only risk and shy away from discussions about returns.
A good financial planner in these cases acts as a devil’s advocate, arguing the case in bull markets for caution and in bear markets for a degree of adventure. The goal in both scenarios is to create a sense of equanimity in the client about markets and a focus on the long term.
Of course, none of this is easy. And it’s one reason why building and implementing a financial plan all on your own is so difficult. People naturally tend to become emotionally invested in their own portfolios, so they ride the losers south and never want to give up on the winners. They become overly greedy when markets are up and overly fearful when they are down.
The reasons for these attitudes are well-documented by behavioural economics. The recency effect, for instance, means we tend to be overly swayed by the most recent news. Rising markets make us want to take on more risk. Falling markets make us want to run for cover.
Trying to manage your financial plan undirected also leaves you prone to the illusion of control. You start to think you can time the markets, getting in and out at just the right time, picking winners and selling losers according to what you read in the weekend papers.
When this fails to work, you can then succumb to loss aversion and herding. You start to place a greater value on avoiding a loss than on the possibility of making a gain. Your confidence shot, you then start to go with the pack, selling as others sell and buying as others buy.
Returning to first principles
If nothing else, a planner is someone to hold your hand – a person who stands between you and all your own worst instincts. A planner will cool your excitement in the good times and ease your worst fears in the bad. Not being emotionally invested allows the planner to return your focus to first principles – asset allocation, diversification and the value of sticking to your plan.
Even more importantly, a plan sets expectations right from the start – building in the possibility of good and bad markets throughout your investing lifetime while keeping your eyes on the main goal.
How hard this is to do for the average person can be seen by looking at the performance of global share markets over nearly a quarter of a century. Using the MSCI All Country IMI index as our benchmark, the annualised return of global equities from 1995 to 2019 in pound sterling was just under 8%. Yet a quarter of the time – in six of those 24 years – the calendar year return was negative. On two occasions, in 2002 and 2008, the market was down by more than 20%.
While all of us may swear we can ride it out, you really don’t know until you’ve been tested. So the planner’s role is not only to teach you about the expected returns of markets over your horizon but to get you acquainted with the possible sequence of those returns from year to year.
Talking about the ‘average’ returns is all very well, but we rarely experience the average. In the case above, only in a handful of cases have returns been close to that 8% average. In some years, like 2016, the return was well above 20%. In others, the opposite.
Focusing on the goal
Amid all that volatility and unpredictability, the ultimate value of the planner is keeping you in your seat, cushioned if necessary by lower volatility bonds, and focused more on your goals than on the year-to-year returns of your portfolio.
Of course, changes can be made to your portfolio, but this is ideally done in a structured, systematic, premeditated way based on how markets have moved in the intervening period and on your risk appetite, circumstances and goals.
The reason for this disciplined approach is that the premiums you are targeting in the financial markets are not regular. They don’t show up in the same places at the same time. That’s why you diversify and why you avoid trying to time your entry and exit points.
The advantage of having a planner holding your hand, talking you off the ledge, or bringing you down from your high horse, is to return your focus to all the things you can control and, while recognising the inevitable emotions, to remove them from the actual investment process.
This is a tough job to do on your own and the evidence from tens of thousands of people, who have been properly advised, is that the real value of having a financial planner is the peace of mind it gives you, the sense of security and confidence about the future.
The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.
This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action.
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