Editor’s Note: Late in September, Paul Merriman, editor and publisher, met with the Merriman investment advisors to share ideas on how to persuade investors to make changes that will bring them more success. This issue of FundAdvice.com is an edited transcript of that round-table conversation.  Participants included Jeff Merriman-Cohen, Cheryl Curran, and former financial advisors Ed Ward and Jim Whipps.

Paul: We’re here today to talk about what we tell people who have a portfolio that is not properly balanced to meet their needs. It seems simple to figure out and tell people what they need to do. You can convince people on an intellectual level that they should make a change. But many investors have a hard time actually making changes. So what can we as professionals say to try to encourage people to take better care of themselves?

I have sat in meetings with each of you, and it is fascinating to me the different ways you help people through this difficult process.

Jeff: If this was just about people in a perfectly rational world, there wouldn’t be a need for this discussion. But as emotional beings we don’t interact with our investments in a purely rational way. Each one of us as an advisor has to work in a real-life, thinking, breathing, feeling world that investors all experience.

Moderator: Let’s focus on some real-life cases of people we have helped.

Ed: I met with a couple whose only significant financial asset other than their home was the husband’s 401(k). He was retiring and rolling that money into an IRA. As we talked, it became increasingly apparent that his wife felt very insecure. Her husband’s risk tolerance was much higher than hers, as he is aggressive by nature. She felt she had no control. She had this tremendous sense of insecurity and lack of control over her own life, and just philosophically, I don’t think anybody should have to live that way.

Paul: I remember this meeting. It was early in 2000, wasn’t it?

Ed: Yes, and the market had just started down. The wife wanted to act very conservatively in order to moderate his aggressive posture. They were at an impasse.

We suggested what we hoped could be a win-win solution. Many people don’t realize an IRA can be split into multiple IRA accounts. We suggested they divide his IRA into two, giving her a power of attorney over one of them so she could invest in a way that was comfortable to her. With the other, he could invest as aggressively as he wanted.

They took our suggestion, and we managed the money in the account that she controlled. He hired another manager for his account, which was invested very aggressively. The other manager lost more than 50 percent of his portfolio, while hers actually had a slight gain through the bear market.

Fast-forwarding three years, we met with them earlier this year. He had realized that being aggressive wasn’t necessarily a good thing. We helped them see that they had enough money to last the rest of their lives without taking big risks that could jeopardize that position.

Now they have consolidated their IRAs into the one that she controls. They are both happy with this arrangement. He used to want to be able to go to a cocktail party and brag about the hot stocks he was investing in. Now he sees that he doesn’t need to do that.

Cheryl: I’ve had clients who wanted to take a lot of risk with some or all of their investments. We’ve talked about whether, if they did take a lot of risk and it turned out very favorably for them, an abnormally high return would really change their lifestyles. And in most cases it’s not going to change their lifestyle at all. So then we back up and say OK, if it’s not going to change your lifestyle, why are you taking this extra risk? Why are you putting yourself in a position where you could take a 40 or 50 percent loss?

Ed: Frequently when we meet with a new client, our job is to determine how long their money is likely to last. If they don’t have enough assets to meet their goals, we know they need to make some tough choices.

They can choose to work longer. They can choose to save more. They can choose to live on less in retirement. They can try to get a higher rate of return. Rarely, if ever, have I seen anything impact a client’s financial future more than their lifestyle and their cost of living.

If somebody who would like to spend $80,000 a year in retirement can instead spend only $70,000, we can show them how that gives their portfolio much more staying power than they would get from a higher annual return. When somebody is approaching retirement, it’s a little too late to count on the power of compounding. Usually at that point it’s their rate of consumption that’ll make or break their plan.

Paul: I have found over the years that very few people know what rate of return they need in order to be financially secure in retirement. Just getting that one piece of information can be a major turning point for many people.

Cheryl: Absolutely. People are often surprised to learn that they can reach their goals with a much lower investment return than they had thought. A lot of times when I sit down with them they have had a lot of anxiety. There’s a tremendous relief to realize that they don’t have to take on all this risk to get where they need to go. They can be very moderate and sleep at night and not worry about their investments on a daily basis. And in a lot of cases it’s a big lifestyle change, especially for someone who’s retired.

Jim: I am reminded of a client who was shooting for higher returns. He was caught up in the camaraderie with his buddies at the country club. He wanted the bragging rights to be able to claim: “I’m getting 20 to 25 percent.”

He is a very successful businessman who went through a really tough period. Not only did his investments lose a lot, he suffered some serious business losses. He had to sell some properties and restructure what he was doing.

His almost automatic response was “I need to make it up, and I need to make it up quickly.” I think part of his worry was his competitive standing in his group of associates, who were all very successful. Our job was to help him understand that he really didn’t need a very high rate of return, and that in fact he would actually be better off in the long run if he took a more moderate approach rather than trying to hit a home run.

And it’s interesting that even in a case like this where someone is kind of shell-shocked and the need to change is somewhat obvious, it’s still difficult to not only change but to also back up and take a little more moderate perspective.

The analogy I used with him was to imagine driving down a street and seeing somebody go whizzing past who’s in a big rush. He goes flying by, putting himself and other drivers at risk, and then two lights down the road you catch up with him.

And then he speeds off again, and three or four lights down the road you catch up with him again. He is taking a lot of risk while he’s trying to make up time or perhaps just being competitive. And in reality he’s not getting ahead of the drivers who are moving along with the traffic.

And in some cases you’ll see that the police have picked him up and he is stopped on the side of the road while all the traffic he was trying to beat goes on its way.

Through that sort of discussion we finally were able to convince this businessman that what he needed wasn’t bragging rights. The most important thing was to have a strategy to benefit himself and his family.

Then he asked me if perhaps it was the wrong time to make a change. What I often tell people is: “It’s always the right time to make a change if that change will either diversify you better or protect your assets better. If you’re not making a change for those reasons, than, yes, you’re probably better off to stay where you are.” This is true regardless of what has been happening in the market.

Jeff: A fundamental error that many people make is believing that it’s possible to understand what’s going on in the market at any given time. The truth is, when we talk about what the market’s doing, we’re always looking backward. It’s hard to convince people that there’s no way to look into the future. So we can only draw conclusions about what’s ahead based on looking backward. Sometimes it helps if people can understand that the past is the past and the future is something totally separate.

Paul: That’s contrary to what most of the financial community preaches. The industry wants to convince people that the professionals can show you what the future looks like. Their message is: “We know where the economy is going to be six months or a year from now. We know what earnings are going to be. We can help you take advantage of this insight.”

Jeff: Yes. In fact it’s worse, because it’s designed to manipulate people into making financial decisions. If you watch financial television shows for awhile, you’ll see the cast of characters they parade before the public. There will be somebody who’s selling research from a particular brokerage house, then you’ll see a portfolio manager who’s selling the merits of a mutual fund, then CEOs and controlling parties of public companies … everybody coming on to sell something, one after another.

Then they’ll pause from that process to run paid advertising. The result is a variety of different selling processes hitting you one after the other. There’s no actual value or benefit to any of that. It’s all just noise.

Moderator: But it’s all very carefully presented in a way designed to make viewers think they are getting insights and education, the inside story. They are made to feel that they are “in the know.”

Cheryl: In one day of financial broadcasting on television, viewers see people who are pessimistic and people who are very upbeat about the market. The investor will choose to believe whichever one they choose to believe. But just because people are on television doesn’t mean they know what’s going to happen in the future.

Jeff: That’s right. There’s no actual value or benefit to any of it. Our job is to get people to understand the truth so they can make better decisions.

Moderator: It’s obvious that teaching is an extremely important part of being a good financial advisor. This has always been a high priority for Paul, and I sense it is a high priority for everybody at this table.

Jim: I would phrase it in a little broader sense. We have an unusually good ability to educate people, and we do it in many ways. I think what we have is an obvious passion for educating people so they understand the basics. When we take whatever time is necessary to help them understand those issues, whether it’s in a workshop or an individual consultation, people realize that our passion is helping them to understand how investing really works.

Paul: I love that word “passion”, Jim. We do have a passion for educating. We have a passion for getting people to understand the choices they must make and how those choices will impact their financial future.

Jim: I often try to help people understand that there’s a difference between having an investment strategy and having a collection of investments. For the most part, investors don’t have a strategy. They have individual investments that are often just a hodge-podge of holdings – and they don’t have any idea how these interact with each other. Do they all go up together? Do they all go down together? What is the overall level of risk in the portfolio?

I teach people that a good strategy has key elements like diversification, a sensible target rate of return and an explicit plan for controlling risk and keeping fees as low as possible. With those elements, you can have a plan that is thoughtful, systematic and strategic instead of just a collection of investments.

Moderator: Jim, you have painted a clear picture of the kind of investment plan we want people to have. Many of the people who come to our workshops and who we meet with individually may have an issue with trusting a new advisor. I wonder if we can talk a bit about this issue of trust.

Ed: Yes, we see people who are very skeptical as they talk to us because they have been burned in the past by professional salespeople who have made them feel like they were best of buddies.

Cheryl: They’ll often say “I don’t know if I can leave my broker because he or she is so nice.” Many people don’t realize that there’s a huge difference between a broker, who is essentially a salesperson, and an independent financial advisor who can work without a conflict of interest.

Before I came to work here, I worked at a regional brokerage firm, and I know how those firms work. There are definitely things they have in their inventory to sell, there are stocks and funds they are promoting. The word comes down to the broker: Sell this!

Moderator: I think this difference between brokers and independent advisors is the difference between selling products and solving problems. Brokers focus on selling products. It’s what they are trained to do and what they are compensated for.

A broker doesn’t win any “points’ for having clients with successful portfolios. This is nice, of course, but the broker’s superiors don’t really care about that. What they want the broker to do is generate income, and that comes from selling products, especially products that pay high commissions.

An independent advisor who doesn’t sell products, on the other hand, has the ability to solve problems first and then recommend products when those products help solve the problem.

Ed: I don’t think most investors know what rate of return they need to meet their goals and make their assets last the rest of their lives. As Paul said, this information can make a huge difference. Once somebody knows where they stand, things start to make sense, and their options become clear. Their world completely changes. Then it’s their choice of what it will take to satisfy them. Helping people solve this problem is one of the more important things we do.

I would say that 90 percent of the people in the investment business don’t know how to figure out the rate of return an investor needs, even if the investor is savvy enough to ask that question. So most brokers in that situation just change the focus to selling products. And this is exactly where so many people get in trouble without realizing it.

Jim: I recall working with a client, a couple who had a multi-million dollar portfolio and who were about ready to retire. After two years with another advisor, they had lost over half the value of their portfolio. There was no doubt in their minds they needed to change something because they were in real trouble. But they weren’t sure what change to make. The broker they had worked with, who unfortunately lost this money on their behalf, was a friend, and they still considered him a friend. So there was this emotional bond there, but they knew they couldn’t continue in that fashion

Paul and I spent a lot of time helping them to understand the issues and why they got into the trouble they did with their previous manager. Our objective was to educate them on how to avoid such losses. After a time they saw that our interest was not in selling products but in solving problems. At that point it became easy for them to decide to work with us.

Paul: What do you tell the investor who comes to us after being badly hurt in a bear market? They’ve gone to cash and fixed income, and they want to be someplace that’s totally safe. We know they should be taking at least some risk in order to out-pace inflation and taxes. How do we get them to be willing to take some risks?

Jeff: My approach is to start with a discussion about the most recent Dalbar research study, which shows how awful investors’ results have been when they follow their own instincts in getting in and out of the market. Over a period of 19 years, the average U.S. equity fund investor made less than 3 percent per year in returns, less than inflation, while the Standard & Poor's 500 Index compounded at 12 percent.

This happened because investors moved in and out of the market following their emotions or hunches instead of adopting a discipline and following it through the normal cycles of the market.

The problem is that people have a tendency to do what feels good, and what feels good is typically to jump in when the market’s done well, then jump out after the market’s done poorly. The result is that people spend most of their time on the wrong side of market cycles. So a starting point for me is to educate them on that.

Sometimes it works to make change in small increments, not all at once. If they should be 60 percent committed to equities and they don’t have any, it may be emotionally easier if they go half the distance, to 30 percent, for the time being. It’s our job to get them to commit as much as possible and then to reeducate them on a regular basis so we can get them to gradually make their transition to wherever they should really be.

I have told many clients over the years that part of what they pay me for is to challenge their thinking. If a client is overdosing on either fear or greed, it’s my job to tell him that’s the wrong decision.

Cheryl: When somebody is feeling emotionally comfortable with the market, it’s usually not a great time to be increasing their commitment to equities. And the opposite is true: When you’re a little down on the market, unhappy and uncomfortable – that’s usually a very good time to invest. The best investors understand that their emotions are almost always going to direct them to do just the opposite of what they should do.

Moderator: One thing that sometimes leads people astray is the concept of loyalty. It seems to me there is an important difference between being determined to follow a discipline, which is a good thing if the strategy is sound, and being loyal to something that doesn’t really deserve loyalty. I wonder if we can explore this a bit.

Ed: The goal in financial planning is to make the best possible decision that you can, based on how things are today and knowing that things are likely to change in ways you can’t fully anticipate. So you have to be willing to change your tactics again in the future.

I’ve seen people come to us who have inherited a portfolio that was absolutely right for circumstances that existed in the past. Unfortunately what often happens is that the person who sets up the portfolio knows it will go to somebody who may not be financially sophisticated. So he’s likely to say “Don’t change it. This is what I want you to have. This is all you need.”

They feel that making a change would be disloyal to whomever it was who told them that. And we’ve seen devastating consequences. What worked very well yesterday or over the past five or 10 years has very little chance of being the best solution in the future.

Paul: Several years ago we helped a new client who had worked all his life for AT&T. He had staked his whole future on this one company, and when he retired a few years ago, AT&T stock was selling at $60 a share. That stock was all he owned, but he had enough of it that he felt comfortable giving his kids a bunch of money.

Cheryl: He was the one who gave one of his sons $80,000 to build a home, right?

Paul: Right. Then AT&T stock went down and down and down, all the way to $16 a share. In a short while, this man went from having more than he would ever need in his lifetime to suddenly discovering he didn’t have enough money to meet his own needs. Somebody who has everything riding on one stock is putting his financial future at huge risk.

Jeff: Smart investors find risks that are worth taking, risks that give a premium return. This is what we call the premium for risk. Stocks of small companies have a premium return because they are riskier. The same is true for value companies, which in the aggregate have higher returns than the more popular growth companies.

 However, there is no expected premium return for the risk of owning just one stock. If that one stock turns out to be a great winner, that is the result of random luck. And for every stock that turns out to be a great winner, there are dozens that are only average at best. So the person who owns just one stock is taking a huge slice of risk without giving himself any predictable premium beyond sheer luck.

Cheryl: There are people whose jobs, pensions, benefits and 401(k) investments are all wrapped around just one company. They see that the company has been good to them, and they have all this loyalty.

Paul: Loyalty is good if it’s directed to the right place but awful if it is applied in the wrong place. I recently talked to a client who had his whole 401(k) in his company’s stock. I asked why, and he said it was loyalty.

I told him I wanted him to make a choice: “I have no question that you and your family are going to be better served and likely get higher rates of return with a diversified portfolio instead of just that one company you own. So, here’s your decision: You choose whether you want to be loyal to your company or loyal to your family. Which is more important to you?”

That got him to think about it in a different way, and he concluded that his family was more important.

Moderator: It’s interesting to think about what it means to be loyal. I think there are two parts of it. First and foremost, if you are loyal you do no harm. Second, to the extent you can, you do good. That’s the way it is with friends, that’s the way it is with family, that’s the way it is with the military, that’s the way it is with just about anything you can think of.

If an investor’s loyalty is to his family, his first duty is to do no harm. And that means not putting the family at great financial risk. The second duty to family is to do good, and that is accomplished by choosing a sensibly diversified portfolio.

Someone trying to be loyal to a company wants to avoid harm. But he’s not doing the company any favor by owning the stock. And what’s the risk to his company if he sells his stock? Is the company going to suffer from that? Are his bosses going to experience any higher likelihood of losing their wealth? No, not at all.

So the choice could be stated like this: Be loyal to your company, and the cost is putting your family’s future at risk. Or be loyal to your family, with no downside effect at all on your company.

Jeff: I think company loyalty is measured by how you work and help your company accomplish its mission. It includes taking care of yourself, and that certainly includes investing your savings intelligently.

Paul: I sometimes ask investors to think of themselves as fiduciaries. A fiduciary is somebody who is responsible for someone else’s finances. An example is a trust department at a bank. They must act prudently, and they can be sued if they don’t. I’d like to see more people take that attitude toward their family’s money.

Cheryl: This is a real challenge for many people. They have to ask themselves: “Is my portfolio there for fun and entertainment, or is it there to provide for my family’s retirement?” Some people get up in the morning and they are excited to hop on the computer and find out what’s going on in the market. It is entertainment for them. But successful investors get their entertainment somewhere else. They want their investments just to be there like a good tool that does its job for them.

Jim: When we’re trying to help people make positive changes, it’s important for everybody to remember that change is a necessary part of life. There’s no way you can establish a plan today that’s going to get you to your end goal without some tweaking and change along the way in order to reach your goals in the most satisfactory manner.

Change is not an enemy. In reality, it’s an ally to make us effective in getting where we want to go.

Paul: That’s a great point, Jim. And here’s something else I hope people will consider. When I recall all the investment portfolios I’ve seen over the past 35 years, one thing sticks out for me: Investors who are either too aggressive or too conservative are the ones likely to get in trouble. History says that the middle of the road is where you get the big reward.

People who have taken a middle-of-the-road approach, a moderate approach, have consistently been the most successful. They are the ones who are likely to have more money to enjoy during their lifetimes and more money to leave to their families at the end.

Moderator: Thanks, Paul. That’s a great thought to end with. Thank you Jeff, Ed, Cheryl and Jim for sharing these insights with us for FundAdvice.com readers.

 

 

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