How Do You Pivot a Client's Financial Strategy Due to Changing Market Conditions?
When market conditions shift, financial professionals must adeptly navigate the waters to adjust their clients' strategies, as explained by a seasoned Financial Planner who tackled changes in risk tolerance. Alongside expert perspectives, we've gathered additional answers that provide a spectrum of strategies, from integrating defensive stocks to employing hedging with options. These insights reveal the dynamic nature of financial planning in response to an ever-evolving economic landscape.
- Adjust for Risk Tolerance Changes
- Implement Core-and-Satellite Strategy
- Integrate Defensive Stocks
- Shift to Dividend-Paying Assets
- Boost Cash Holdings for Liquidity
- Rebalance Towards Growth Sectors
- Employ Hedging with Options
Adjust for Risk Tolerance Changes
The only time one should consider changing their financial strategy, in our opinion, is if there is a material change to one's risk tolerance. This can come about in response to the death of a family member, loss of a job, illness, or any other non-market-related event that causes the original goal to change.
Following the original plan with the understanding of meeting periodically to review for changes typically leads to a more successful outcome for the client than changing investments.
Implement Core-and-Satellite Strategy
The recent market correction in the last few weeks required many clients to reevaluate the risk in their profiles. One of my clients was concerned about their potential downside exposure. We ran a stress-test analysis using HiddenLevers to determine the downside potential of their retirement account. The client learned that they had a downside potential equal to a 56% loss in their portfolio. This would wipe out a decade of saving for retirement!
We pivoted their investment strategy to use a core-and-satellite portfolio. By allocating 20% of their portfolio to our active management fund, we were able to reduce their downside risk substantially. Additionally, because of the non-correlated nature of the actively managed fund, we were able to increase their potential upside return by 100 bps without increasing their standard deviation of returns. We were able to build them a better-performing portfolio with the same amount of risk using our actively managed fund.
Integrate Defensive Stocks
In volatile markets, adapting a client's financial strategy can be accomplished by integrating defensive stocks, which typically weather economic downturns more effectively. Such stocks are often found in industries considered essential, such as healthcare or utilities, and tend to provide steady earnings despite economic turbulence. By focusing on these stable sectors, the portfolio gains a layer of protection that can alleviate the impact of market swings.
This approach targets preserving capital while maintaining the potential for modest growth. Evaluate your portfolio and consider incorporating defensive stocks to bolster stability.
Shift to Dividend-Paying Assets
Altering a client's financial strategy to better suit shifting market conditions might involve gravitating towards assets that regularly pay dividends and show lower historical price volatility. This tactic is grounded in seeking out companies with a consistent track record of profitability and a strong history of dividend payouts, which can offer a dual benefit of potential income and reduced risk during times of market stress. In addition to income generation, these assets can contribute to the portfolio's ability to withstand fluctuations, adding a cushion against market turmoil.
Such a strategy seeks to balance the desire for income with risk management. It may be beneficial to explore opportunities in high-dividend, lower-volatility assets for a more secure financial position.
Boost Cash Holdings for Liquidity
In response to an unpredictable market, a prudent move for a client's financial strategy could be to increase liquidity by boosting cash holdings. A larger cash reserve offers flexibility, acting as a buffer against market drops and positions one to take advantage of potential investment opportunities that arise during downturns. This strategy is akin to constructing a financial moat around the client's investments, preserving capital that could be critical if markets continue to falter.
It also reduces exposure to potentially volatile investments during periods of uncertainty. With market conditions in flux, assess the benefits of enhancing cash holdings within the portfolio.
Rebalance Towards Growth Sectors
When the market shows signs of change, it is often wise to rebalance a client's portfolio to favor sectors that are expected to experience growth, also known as sectors with 'strong tailwinds.' This can involve identifying industries that are projected to benefit from current economic trends, technological advancements, or regulatory changes. By reallocating investments towards these promising areas, one can aim for a higher growth potential even when the broader market faces headwinds.
This strategy requires careful analysis of market research to inform strategic decisions. Begin investigating which sectors are poised for growth and consider a rebalance to align with these insights.
Employ Hedging with Options
In an effort to safeguard a client’s portfolio against declining markets, one may employ hedging techniques using options for downside protection. Options serve as a form of insurance, where, for an upfront cost, they provide the right but not the obligation to buy or sell an asset at a predetermined price. This can help cap potential losses if the market were to move unfavorably while still allowing participation in any upside potential.
Hedging is a nuanced strategy that can be tailored to individual risk tolerance levels and investment goals. Investigate how options might serve your financial strategy to enhance protection against market downturns.