Building portfolios to withstand a significant downturn before they happen is the best way to manage when they do
by Gregory B. Gagne, ChFCMr. Gagne is the founder of Affinity Investment Group LLC. He is the 2020 Nominee to the MDRT Executive Committee, and has achieved four Court of the Table and 11 Top of the Table qualifications during his 20-year MDRT membership. He is also a Platinum Knight of the MDRT Foundation and has served on its Board of Trustees. Visit www.affinityinvestmentgroup.com
After waves of speculation in 2019, fears of a severe, imminent recession have mostly subsided within the U.S. financial industry. Stock market indices posted significant gains in 2019, and the yield curve inversion on 3-month and 10-year U.S. Treasury securities disappeared in November. However, warning signs remain: the manufacturing sector has been in recession since August, large businesses are betting on a recession by 2021 and long-term problems like sky-high student loan debt continue to limit consumer spending. Risk also remains from geopolitical factors, including a potential military conflict with Iran and ongoing U.S.-China trade tensions.
American consumers have taken note. A recent MDRT study found that 82% of Americans are at least somewhat nervous that they will be personally impacted by a recession in the next year. This latent anxiety means financial advisors should take steps to prepare now for what could be a wave of panic when the next recession inevitably occurs. With the proper preparation, advisors can steer their clients through economic troubles and avoid a rush of requests they are not equipped to handle.
Defense is the Best Defense
Recessions are an inherent part of the business cycle – they’re never completely unexpected because one is either coming or happening. What is unexpected, unfortunately, is usually the timing, and consumers caught unaware can panic, exacerbating negative financial consequences. Advisors should be in frequent communication with clients about events that are unexpected at the moment – clients who took steps in 2017 to insulate themselves from downturns would’ve been able to face the jitters of December 2018 and August 2019 with less worry.
Building portfolios to withstand recessions before they happen is the best way to manage when they do. That starts, as with all portfolios, with a cash buffer. Many popular personal finance websites recommend keeping anywhere from three months to one year of expenses in cash as an emergency fund. That is solid advice, but emergency funds are not recession-proof – they simply provide temporary flexibility to navigate a crisis, and can usually only withstand one crisis at a time. The buffers most impervious to recessions contain one to two years’ worth of expenses. They need not, and should not, consist of cash alone. Equivalents like U.S. Treasury bills, certificates of deposit and commercial papers should be included in these bulwarks.
The rest of a client’s portfolio should consist of a standard division of stocks and bonds, based on age and financial needs. In the best cases, portfolios constructed in this way can last seven to 10 years before a single stock needs to be sold. Of course, even the best portfolios will lose value at some point, so consistently reinforce to clients that patience is the best medicine for portfolio pains. As long as clients win more often than they lose, they’ve won.
To protect clients against portfolio-driven income loss during recessions, include guaranteed income options in portfolios whenever possible. Pensions are not as common as they once were, but Social Security can be drawn without penalty starting at a client’s full retirement age. Under normal circumstances, it can be better to hold off on Social Security benefits to receive larger payouts, but if a recession is imminent, they can provide crucial padding against lost income from other sources. Annuities are another option for guaranteed income, and advisors should be aware of the changes brought by the SECURE Act of 2019, both for clients and for their heirs.
“Do not try to time the market” is baseline advice, but advisors must hammer it home when the economy starts to head south. The internet is full of stories from the few who get lucky trying this tactic – and rather bereft of stories from the many who don’t. Remind clients tempted to try this route that they have to time the market twice to pull it off. They have to sell before a crash without losing out on market gains, then they have to buy at the market’s lowest point. Both of these events are near-impossible to predict, so the chance anyone gets both right is extraordinarily slim.
When a recession appears imminent, some clients may express a desire to buy substantial amounts of gold or cryptocurrencies, spurred by TV or online pundits. Gold has historically performed well during some, but not all, recessions, and did very well during the Great Recession. However, the inverse relationship between gold and stocks is not absolute – and gold will almost never do as well as pundits claim. Cryptocurrencies sit in an even less secure spot – their exchanges are not insured by state actors, and a recession may not stop increased regulatory pressures as they attract more government attention.
Unlike their financial portfolios, clients’ insurance coverage will not need much recession-proofing. Death does not care about the economy – clients will need life insurance no matter where the market goes. However, for clients or prospects who lack life insurance at the start of a recession, term insurance may be preferable. While these clients may want to convert to permanent insurance down the road, term insurance may be worth the money they can save on premiums in the short-term if they have limited cash to spare.
For clients who have permanent life insurance when a recession starts, their policies can act as a financial crutch. Clients can borrow against their policy’s cash value if their income falls, and can use their policy’s dividends to cover at least some of their premium payments.
If there is an insurance policy that may be a delayed purchase during economic hardship, it may be long-term care (LTC) insurance. Traditional policies only pay out if their holders need care, and they build no cash value over time. LTC-life hybrid policies can come with death benefits, but they can be too expensive to purchase in the midst of a cash crunch. Still, advisors should remember that one in two senior Americans will need long-term care at some point in their lives, and there is no guarantee that clients’ health problems will wait for a recession to end.
Meetings During Recessions
According to the MDRT study, 51% of Americans with advisors would want their advisor to proactively meet with them if a recession occurs to discuss the implications. This is both understandable and incredibly unrealistic. It is human nature to schedule meetings, but if advisors met with half their clients when a recession started, they wouldn’t have time to manage client portfolios.
Regular communication before a recession enters clients’ minds can help allay fears and prevent a rush on your office. In-person meetings and virtual meetings through Zoom can comprise part of this strategy, but so can emails, videos and newsletters. Consider a quarterly video sent to all clients that gives a summary of recent events, your best idea of the future and recommended steps to prepare. My office started such videos in 2003 to help inform clients of our thoughts on a set schedule, and they provide a sense of regularity that helped us get through the Great Recession without mass client panic.
Lectures and webinars for clients can help develop their own financial knowledge base. Over time, offering these opportunities can help prevent a deluge of questions and inadvisable requests during downturns, as clients will be able to depend more on themselves for logical and emotional reassurance.
New Business Opportunities
Recessions come with a bittersweet opportunity to expand one’s client base. MDRT’s study found that 62% of Americans without financial advisors would seek one out if they experienced a significant change in their household income or wealth. Sadly, in a recession, such changes are more likely to be negative, so advisors must approach prospects in this situation with care. First appointments should always be free consultations, and advisors must be upfront about the costs and fees of their services.
About half of Americans with advisors found them through a family member or friend’s referral, and that trend should only continue in a recession. To reach other prospects, public speaking events can put advisors in the public eye. Either way, advisors should also keep their websites up-to-date, including optimizing them for mobile browsers.
There may or may not be a recession in 2020. The exact timing, however, matters less than being prepared for one at any time at all. By taking the right steps today with client portfolios and communication practices, advisors can be ready to navigate their clients and offices through the next storm, whenever it arrives.