Don´t Let Today’s Volatility Enrich Your Private Banker
Sep. 13, 2011
Since 2008 markets have seen a lot of up and down movements. For instance, the German Dax has lost more than 30% since this year’s high in May. The Dow is down by almost 15%. And the Eurostoxx50 has even lost about a third. Back in 2009 the picture looked just the opposite. Many indexes gained 40%, 50% or even more from their lows. Other asset classes have shown a similar picture: just have a look at the charts forcommodities, government bonds (depending of course on the country) or currencies. Recent years have truly been a roller coaster ride in the global financial markets.
In 2009, just when stock markets hit their lowest lows, we published a report with the title ‘Insufficient Client Focus – A Survey of European Private Banks’. This report showed just how pro-cyclical and short-termist the advice of many (but not all) private banks was at the time. The closermarkets fell towards their (eventual) lows, the more advice private bankers issued to avoid (cheap) stocks at any cost, invest in (already highly priced) government bonds and stick to cash. Even clients with some risk appetite were advised to trade out of stocks.
In most cases private bankers suggested either having no stocks at all in asset allocations or keeping the stock portfolio insignificant, an approach that suggested a high degree of confidence in their own ability at market timing. A confidence that, as events unfolded, was proved to be unjustified.
Today, we have a similar situation: bankers advise their clients to switch their assets into safe havens such as gold, Swiss Francs or Asian currencies and cash. But only a few months ago, when the stock indexes approached their highs, many banks increased the stock quota in their asset allocation recommendations.
It’s exactly this kind of behavior, market timing and trading in and out of asset classes that enriches the banks and reduces performance forprivate investors. Trading fees and commission on trades can have a big impact on portfolio performance. (See our Wealth Guide "Cut the Costs of Wealth Management").
But what should an investor do when markets succumb to turmoil or even crash? Just stand by and watch his or her wealth crumble? Numerous studies have shown over and over again that for the overwhelming majority of private or professional investors it is almost impossible to time the market correctly over a longer period of time. Burton G. Markiel, finance professor and author of the seminal work "A Random Walk Down Wall Street" writes:
“Mutual-fund managers have been incorrect in their allocation of assets into cash in essentially every recent market cycle. Caution on the part of mutual-fund managers (as represented by a very high cash allocation) coincides almost perfectly with troughs in the stock market. (…) Cash positions were also high in late 2002 and in March 2009, at the trough of the market.”
Substitute wealth adviser for mutual fund-manager and you get exactly the same picture. Yet, if market timing does not work, what should you as an investor do in a volatile phase such as the one we are currently facing. There are five golden rules that summarize the collective wisdom oflibraries full of research on modern financial markets and investor behavior:
1. As famous investor Warren Buffett remarked: “Be fearful when others are greedy, and be greedy when others are fearful”. So, do not let emotions cloud your decision making: abull market should not make you overly happy and a bear market should not throwyou into panic, neither should this happen to your private banker.
2. Your overall strategy as well as your general risk tolerance should always remain the same (with the possible exception of your personal situation having changed). Your private banker is there to execute this strategy – regardless of market cycles.
3. Watchyour private banker or wealth manager closely – always. Question their decisions, especially in times of strongly growing or falling markets. Get on their nerves. Pepper them with questions. Make them earn their money.
4. Do not buy into securities you do not understand or which your wealth manager or private banker cannot reasonably explain to you. This is especially true for complicated structured products or black-box hedge funds. Such products will come back and haunt you during times of crisis.
5. Do not hesitate to ask your private banker to revoke any trades you have doubts about. If you feel that your wealth manager isn’t executing your agreed upon strategy, do not hesitate to find a new private banker.
And don’t forget to read or reread our guide on asset allocation, which can help you to evaluate the level of risk you can stomach objectively and independently of temporary market sentiment.