Three steps to effective conversations about risk

Wednesday, February 29th, 2012

Among the most impor­tant things that good advi­sors bring is the abil­ity to help clients make the right trade-off between risk and return … and also to help clients under­stand the crit­i­cal impact of the time frame over which they hold invest­ments on the volatil­ity they experience.

One of the most impor­tant con­ver­sa­tions these days is about the amount of risk that clients should take in their portfolios.

This month’s col­umn in Invest­ment Exec­u­tive out­lines three steps to make that con­ver­sa­tion an effec­tive one.

Step One: Talk about long-term returns

You could start by remind­ing clients of after-inflation returns for dif­fer­ent invest­ments for the 84 years from 1926 (as far back as we have really good data) to the end of 2009.

This com­pares large cap US stocks to inter­me­di­ate, 5 year Gov­ern­ment bonds and T bills. Note that you should frame this in terms of real, after– infla­tion returns — what really mat­ters to clients invest­ing for retirement.

Note that after infla­tion, stocks have returned three times bonds and ten times T bills.

Then trans­late that return into the real return on client portfolios.

For some­one invest­ing $100,000 in stocks, the after-inflation appre­ci­a­tion of $259,000 is almost five times that in bonds and almost twenty times the gain in T Bills, which just barely beat inflation.

Step Two: The odds of los­ing money

Next, talk to clients about the his­tor­i­cal expe­ri­ence of los­ing money in stocks after infla­tion, based on dif­fer­ent hold­ing periods.

His­tor­i­cally, hold­ing stocks meant that after infla­tion you lost money about one in three years.

Look­ing at three year peri­ods reduces the chances of los­ing stocks to about one in four.

In ten year time­frames, investors lost money 12% of the time — based on the expe­ri­ence since 1926; you have to go out to twenty years to com­pletely elim­i­nate the chances of los­ing money in stocks.

Step Three: Com­mu­ni­cate this visually

Finally, por­tray the nature of the expe­ri­ence in a way that investors can relate to.

    Lat­est Advi­so­r­An­a­lyst Prac­tice Growth Sto­ries

Tags: Client Portfolios, Conversations, Critical Impact, Government Bonds, Holding Periods, Important Things, Inflation, Investing For Retirement, Investment Executive, Investments, Risk And Return, Stocks Bonds, T Bills, Three Steps, Three Times, Time Frame, Timeframes, Twenty Times, Twenty Years, Volatility
Posted in Dan Richards | Comments Off