Lessons Advisors Learned From the Crash of...

Lessons AdvisorsLearned From the Crash of 2008

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Lessons Advisors Learned From the Crash of 2008


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Copyright © 2009 by Horsesmouth, LLC. All rights reserved.

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Edition 1.0


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Contents


Introduction ..........................................................................................................................51. Own the Responsibility .................................................................................................92. Clients Prefer Absolute Return ................................................................................. 133. Take Defensive Measures ........................................................................................... 174. Get your House in Order .............................................................................................235. Stay Open to Change ....................................................................................................256. Keep Communicating with Clients ...........................................................................29Conclusion ...........................................................................................................................33



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The market crash of 2008 shook the advisory world like a Category 5 hurricane.

And while nobody was surprised it happened, the degree of devastation caught many in the investment business unprepared. What began with a few worrisome winds in the housing and credit markets turned into a

full-scale, broad-based catastrophe. Week after week, the fi erce squall spun across the fi nancial landscape, churning through trading desks and exchange fl oors, wiping out a large portion of the wealth and well-being of an entire industry, and threatening the global economy.

The market crash of 2008 rattled the psyche of fi nancial advisors, who in some cases felt betrayed by their fi rms, their fund managers, and even the markets themselves. Many advisors were slow to recognize the historic nature of this storm (the worst year for stocks since 1974, and one of the worst since the Great Depression). Relying on static asset allocation, advisors failed to protect clients from the downside exposure caused by a “Six- sigma” event. The rare and severe downturn in both stocks and bonds revealed hidden vulnerabilities in traditional defenses.

Waiting out the stormSome advisors began to question the wisdom of “waiting out the storm.” Indeed, with the fi rst signs of a signifi cant correction in early 2008, most advisors did what they’re trained to do: They reassured panicky clients, made a few defensive moves, and hoped for a quick resolution. Many believed the disruptions stemming from massive subprime write-downs and the bailout of Bear Stearns would be short-lived. They predicted (or hoped) the distress felt in the fi nancial sector would not spread to the general economy. Some viewed the 15%-20% Dow decline at that point as a golden buying opportunity. Why miss those inevitable “10 good up days” by cashing out now? This was a normal cycle, they reasoned. Many advised clients to stay the course or dollar-cost-average into the volatility.

As one veteran top advisor said ominously in March of 2008—six months before the market sunk into the abyss, “Right now is a tremendous opportunity for new money investors to invest in the market.”

How are those new money investors feeling today? Like they would have been better off

Introduction“This seems to happen every 25-30 years. And, we never seem to learn anything.” — Buddy S., fi nancial advisor.


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with the old mattress approach?

Other advisors in March of 2008 were more leery: “We are only in the beginning stages of this mess, so we really haven’t seen even the tip of the iceberg,” one cautious advisor said. “I believe we are going to see many, many more defaults. I think it would be wise to sit safely on the sidelines for the time being.”

Indeed, as summer turned to fall, the tempest continued, and worsened. This was no buying opportunity. Experts everywhere began calling it “the worst fi nancial crisis since the Great Depression.” In September the pullback in stocks became a freefall. Congress was debating the future of capitalism, a presidential candidate now infamously suspended his campaign temporarily to deal with the bailout mess, and none of the top minds in Washington or New York could seem to fi gure out how to get banks to lend again.

Nothing felt normalBy year-end, longtime industry giants Bear Stearns, Lehman Bros., AIG, and Merrill Lynch were forever changed—or gone altogether. The government had undertaken a nearly trillion-dollar “bank rescue” plan. Trillions more dollars in wealth had been destroyed in the market in mere weeks. And within the fi nancial advisory community, there was a deepening sense that things might not return to normal anytime soon—even with a new man in charge at the White House.

Advisors wondered what happens to standard diversifi cation theory when all the asset classes go down—and keep going down. “In all the years past, if things got sticky in the equity markets, you could always sell and go to the safety of bonds,” said one frustrated advisor. “Well, bonds are no longer safe.”

Advisors questioned where their clients could seek shelter when the fear became too much. And they began to consider evacuation plans to spare clients the pain of so much fi nancial loss—and the huge burden of rebuilding. Who, after all, can easily afford to rebuild the nest egg in the face of an uncertain future?

Where do we go now?Entering a new year, advisors are still assessing the nature of our current economic pain and the problems that may persist in the future—problems that will impact the investment decisions they make for clients. After living through 2008, few are overly optimistic:

“I think we are paying for many years of excess and greed in many sectors—and it will not end quickly,” one advisor soberly recognized. “This is a case,” said another advisor, “of chickens coming home to roost: Years of overspending, lax monetary policy, and speculation, especially, in new investment instruments that overplayed leverage.”

And despite reassurances from the government that we can restore liquidity (and presumably good times) with massive infusions of taxpayer cash, it feels more like the end of an era: the leveraged era. Dennis Gibb, an advisor in Redmond, Wa., compares it to a giant margin call. And those are never pleasant times. “Wall Street created securities to satisfy the greed of investors,” he said. “As the greed continued, more dodgy product was produced. The fact that the product required little capital but had huge profi ts


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caused the leverage to grow. The decline in liquidity and capital are the piper being paid. I am most worried about a fi nancial defl ationary cycle starting while an infl ationary spiral commences in real products.”

For advisors, bearish concerns haunt them heading into 2009:

Liquidity problems in the municipal bond market•

Further devaluation of the U.S. dollar•

Mounting trade and budget defi cits•

Distrust in fi nancial information•

Looming crisis in Medicare and Social Security•

Possibility of higher taxes affecting corporate profi ts•

Financial standing of large insurers and banks•

Lessons learnedBut if there’s one dividend paid out by a devastating bear market, it’s the new lessons learned and old ones reaffi rmed. In December of 2008, we asked Horsesmouth members to tell us what insights they had gleaned from the historic market break, what they are doing differently in their practices as a result of the fi nancial meltdown, and what investment opportunities they see ahead. We learned that some advisors, a small minority, positioned their clients well for the fi nancial crisis of 2008, utilizing alternative investments, annuities, and cash. Those who were caught off guard—in whole or in part—learned lessons that they will carry over into their future investment decisions. Despite the losses, advisors are making plans for their future, and we’ve summarized them for you in this report.


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One major positive to emerge from this bear market is the return to a sense of personal accountability. During fi nancial bubbles, everyone passes the buck and trusts that it will all work out. In the subprime debacle, impatient homeowners took out loans they couldn’t afford; greedy mortgage lenders

passed on risky loans to aggressive banks and insurance companies, which pawned off the corporate risk to stockholders (and taxpayers); government-sponsored mortgage fi rms packaged and resold millions of bad loans, while Congress and the regulators looked the other way. Nobody wanted to be caught holding the risk bag. And who cared as long as everybody made money on the transactions?

Likewise, fi nancial advisors were lured into selling auction-rate securities, closed-end, industry-specifi c funds and preferred stock that promised “safety,” but in many cases turned out to be bad moves for their clients in 2008. Often, advisors relied on the opinions of individuals who didn’t have direct accountability to their clients. They trusted their fi rms, the research departments, the economists, the product manufacturers, even the market, which turned out to be not as effi cient as many believed.

Trust no oneBut a new ethic emerged from the debris of 2008: Take individual responsibility.

From the failure of trust, the breakdown in responsibility, and the sense of betrayal, advisors who survived 2008 concluded that nobody cared about their clients’ well-being as much as they did. Many advisors decided to stop relying so much on outside agents. They took on more of the burden of investment research and due diligence. And while that presented new challenges—and no simple answers—it was an opportunity to grow as a professional.

“I have learned not to trust economists, strategists, and analysts,” says Giles Bazinet of Dundee Securities, who builds his clients’ portfolios using ETFs and his own research. “Most expert advice is useless when a market falls over a cliff. I have learned to trust no one.”

Own theResponsibility

Lesson #1

“The most important thing I learned is that you have to know exactly what you and your clients own within their funds.” —Scott H., advisor


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Scrutinize managersFor decades, advisors have outsourced to money managers for positive returns and to meet asset allocation targets. But outside managers have a disincentive to raise cash, even when circumstances may warrant a defensive move. Moreover, managers often don’t have the fl exibility in their investment styles to make major tactical moves. In a bear market, advisors found that it was critical to understand their money managers’ sell strategy—not just their buying parameters: “I learned that I can’t trust a third-party money manager to get out of the market,” says Michael Sandifer of the Sandifer Group. “I learned that I did the right thing by getting my clients’ equity fund positions out in January of 2008.”

Last year advisors played detective, sizing up underperforming investments and defending client interests. They learned that their fi rst and foremost obligation was to clients and their well-being—even if that meant trying something new: “Be loyal to your clients and their goals, not fund managers, asset allocation models, and research departments,” says Dennis Nolte of Partners Wealth Management. “If it doesn’t feel right or act right, it isn’t. Fire underperforming managers. Plow through what managers are actually holding.”

Indeed, knowing the inherent risks in a portfolio meant digging into actual holdings and not trusting managers carte blanche: Adds Scott H., who is with a wirehouse, “The most important thing I learned is that you have to know exactly what you and your clients own within their funds.”

Conduct your own due diligenceLast year taught advisors to be more wary than ever of recommended investments—just as advisors have learned in prior bubbles. As one wirehouse advisor summarizes it, “I have purchased investments for clients that the fi rm’s senior management, the research departments, and the rating agencies told me were solid investment-grade investments only to have them blow up. I have learned to trust no one, and to be extremely careful with everything I purchase for clients going forward.”

Steven Chantler of Affi nity Wealth Management adds, “I have decided to only look at investment information from sources that are not trying to sell investment products and pay more attention to risk factors in the markets and the economy in general.”

Richard, in Westlake Village, Calif., adds: “I have lost all respect for company research and third-party research like S&P. I don’t know how many times I heard ‘subprime was contained’ and the economy was in for a ‘soft landing.’ While it will take time and be a signifi cant investment, I am on a quest for truly independent research. I very much believe that the brightest minds on Wall Street must have seen this coming to some degree. It’s all very frustrating. S&P and Moody’s should be put out to pasture.”

Another advisor complained: “The checks and balances were not accurate. We used Morningstar to report equity viability and Moody’s to look at the debt. Neither of these independent organizations provided unbiased evaluations. I am especially discouraged with the bond rating agencies.”


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More advisor lessonsTo own the responsibility, advisors say:

Don’t expect the market to give you a second chance.•

Take action on your gut or years of learned experience.•

Get back to knowing your clients and understanding their needs and concerns.•

Do not keep diffi cult clients. •

Fully understand the investments in which you place your clients.•

Plan for the worst and hope for the best.•

Disregard advice that violates your common sense no matter how eminent the • source.

Read the annual and semiannual reports. If anything doesn’t make sense, sell it or • don’t buy it.

Write out your investment philosophy and distribute it to clients, prospects, and • managers. Review it and revise it quarterly, distribute revisions, and adjust client portfolios to make them consistent with the philosophy.

Admit and correct mistakes—sooner rather than later.•

Keep your own counsel.•

Be skeptical, not cynical.•

Trust your own research.•

Follow the technical indicators.•

SUMMARY

Advisor William F., in McLean, Va., puts it this way: “Long-term is for grandchildren. Be much more fl exible, and trust your own experience and knowledge of clients. Don’t wait for the gurus to speak.”

As advisors head into an unknown future, they know the burden is on them to be the investment expert looking out for their clients. They may not know all the answers, but they’re committed to the search.


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It seems almost too obvious to mention, but it’s true: Clients don’t like to lose money. They’d prefer to eke out some kind of positive or slight negative than to incur heavy losses. But advisors have been conditioned to think that occasional heavy losses are the required burden of being in the market—the price of

investing for the long term. Advisors train clients to think about risk in relative percentage terms; clients are asked whether they could “handle” a drop of this or that magnitude. But 2008 revealed, for many advisors, that their prior discussions with clients hadn’t fully uncovered clients’ true temperament for loss. The bottom line: Almost nobody was thrilled about beating benchmarks while still losing lots of money. A relative victory didn’t seem good enough for most clients after two ferocious bear markets in six years.

Quantify risk in absolute termsConsequently, in 2008, advisors discovered they must fi nd new ways to address risk with their clients. An advisor with a major wirehouse writes, “I have learned to ask my clients, ‘What percent of your assets do you want to put at risk?’ and then I quantify what that would have meant in loss of actual dollars in a minus-50% market.” Adds advisor Arthur M., “I learned long ago that most clients are more interested in absolute performance than relative performance. No matter how much you try to preprogram your clients for the eventual bad year, you risk losing them when that bad year shows up.”

Many advisors in 2008 decided to focus their risk tolerance discussions on return rather than volatility—basing decisions on meeting goals, rather than beating benchmarks. “Target-return allocations are better than target-risk-tolerance allocations,” says Paul B. of a regional fi rm. “Find out the rate of return your client really needs. Find an allocation that meets that need. If the realized returns continue to exceed the need, adjust to a more conservative position. This provides more protection from the risk of market cycles. Conversely, if the allocation is underperforming the need for more than a year, migrate the allocation to a more aggressive stance. Applying this approach carefully tends to reduce the cyclical losses

Clients Prefer Absolute Return

Lesson #2

“Clients want to know you are helping them with an active, disciplined strategy, not shooting from the hip and not rigidly ignoring the realities that are as plain as the nose on your face.” —Paul B., Dallas, Texas


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and stabilize the client’s returns. Clients gain confi dence and make more referrals when they are getting the returns they need on a more consistent basis.”

Consider guaranteed productsRetirees face risk from longevity and infl ation, which is why advisors have long justifi ed putting retirees in equities, while setting aside a portion of the portfolio for withdrawals. Clients who began their retirement in 2008, however, learned about a third risk: sequence-of-return (SOR) risk. As such, many advisors began looking more favorably toward the guarantees offered in some variable annuities in 2008, a record year for annuity sales.

“All who want to one day retire have to address three risks: longevity, infl ation, and sequence of returns (SOR),” says Mac M., in Richmond, Va. “Only one investment product gives you the opportunity to invest in stocks and bonds, which is what you need to do to address longevity and infl ation risk but also protects you from the biggest and potentially most damaging risk, SOR risk: variable annuities with guaranteed minimum withdrawal benefi ts.”

Other advisors concur: “I believe that living benefi ts, whether Guaranteed minimum income Benefi ts (GMIBs) or Guaranteed Withdrawal Benefi ts (GWBs), are of signifi cant value to our clients and ourselves as representatives,” says Matt Beverungen with Beverungen and Company. “I do not see or hear the Suze Ormans of the world castigating living benefi ts for their ‘high cost’ now or calling fi nancial planners greedy for selling them. Who wouldn’t like to go back in time and add a guarantee to their clients’ portfolios as of September 2007?”

But Brian in Boston cautions, “I learned that when a retired client needs 7% or more in income from their portfolio, I must tell them it cannot be done without a high degree of risk of losing principal and/or running out of money. Over the past two years, products were available to provide 7% or more from what appeared to be low-risk investments. My next concern is VAs with ‘guaranteed income’ benefi ts. How long before they blow up?”

Regarding the risk in variable-annuity guarantees, advisor Mark H. concludes, “If we go through a Japan scenario (15- to 20-year period of overall declining stock prices) along with signifi cantly lower interest rates, then the insurance companies are going to be in a world of hurt. But even then, would you rather own a VA with guarantees that might or might not be met by the insurance company, or a mutual fund with no guarantees?”

Help clients stay on budgetThis year many advisors counseled clients that they were depleting their principal because of unchecked spending. They urged clients to face the new reality of a low- or negative-return environment. Clients accustomed to withdrawing more than 4% hoping the market would bail them out had to stretch their cash for a longer period: “We learned to work to ensure there is enough cash for two years, so that long-term positions can be held and not sold,” says advisor Jeanice H. “While we have tried to instill this discipline, unfortunately some clients overspent their budgets and they are having a tough time.” Adds Josh N., “I’ve learned that I need to be more vigilant in


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insisting clients build a larger cash reserve and that they pay their debts down more aggressively.”

More advisor lessonsRegarding clients’ preference for absolute returns, advisors offered the following observations:

“Clients think in percentages when their portfolios are going up and dollars • when their portfolios are going down.”

“No one can stand volatility when they are experiencing it.” •

“Some people should never be in equities. They just don’t have the temperament • and we should not try to change that.”

“Know your client—always review the plan—and insure the time horizon that • you are operating in is the same as your client’s.”

“Living benefi ts are the only things that provide a ‘silver lining’ in the cloud of this • terrible market, which extends back to the fall of 2007 and features a decline in most clients’ portfolios of 40%-50%.”

“It’s totally worth every dime of cost for the guarantees of a life income.”•

“A guaranteed income for life is very appealing for people with no pensions and a • crashing market.”

“A guaranteed income is better than a pile of money.”•

“Variable annuities with income riders help my clients sleep at night.”•

“Those clients with the least in savings are the most susceptible to the hysteria • spread by the Suze Ormans and Jim Cramers of the world. The clients with a nice investment package pay no attention to these people and rarely look at their quarterly statements.”

“Redo their plans if their goals, objectives, time frame, asset allocation, or • anything else changes. Make sure their overall objectives are being met. Redo retirement planning assumptions and college education planning as needed.”

“Remember, clients do not limit their perspective to the last 52 weeks or only to • calendar years. They remember the highest point and lowest point their accounts have reached. And from peak to trough, the market was down over 40%. This has happened only four times since 1950.”

SUMMARY

While clients often think in relative terms during bull markets (“My portfolio is up 15%”), they feel absolute losses during bearish periods (“I lost $50,000”). Advisors need to fi nd out what returns will meet clients’ fi nancial objectives and consider a more conservative approach for those with less stomach for risk. Tempering clients’ expectations and preparing them for uncertain times ahead will help them adjust their lifestyles and expenditures.


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It’s often said that the best offense is a good defense, and 2008 taught advisors to pay more attention to what can go wrong in their investment approach and to take preventive measures. With awareness of sequence-of-return risk and the knowledge that it takes years to make back a 30%-40% portfolio loss, advisors learned that a

defensive move to larger cash positions can save their clients from unneeded distress.

Don’t be afraid of cashFor many advisors, the notion of taking clients to majority cash positions goes against everything they’ve believed as investment counselors. In the last 12 months, however, cash was king. “I got my retired and soon-to-be-retired clients out of the markets in December 2007,” reports Glenn M., who is with a wirehouse. “My advice is to always have lots of cash on hand.” Another FA, Joseph O., advises, “Raise cash early. Balanced portfolios with lots of dividend income weather the downturn best.”

Says Stephen W., “Frequently, in the last 25 years, I have raised my clients’ cash positions to levels my peers, my fi rms, and my clients questioned—only to be found to be both early and right. This last year and two months is no exception.”

James Curry of the Wiseman Agency notes that “risk is not just measured by volatility but the chance of loss of capital. I will be more willing in the future to advise that a client hold a larger amount of their assets in cash.”

Develop a sell strategyWhile advisors have traditionally focused on buying opportunities driven by fundamental research and P/E ratios, disciplined selling and profi t-taking became more important in 2008. Many advisors established fl oors for losses at 10%-%15 percent, rather than allowing losses to continue. “Always use stop orders,” says Gary H. “A sell discipline is more important than anything else.”

Part of any sell strategy is learning when to take profi ts off the table. “We just cashed out (in November) over a 10.5% return over a 62-day period in 20-year Treasuries,” says Steve Gibbs of Mahalo Financial. “Don’t get greedy. This market is too unforgiving and volatile.”

Take Defensive Measures

Lesson #3

“We are not sure where things are going but have positioned portfolios as though things will get worse.” —Jeffrey E., Erie, Pa.


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Enforce investment disciplineAnother advisor, Ginny P., agrees with a disciplined profi t-taking approach that she will continue as the markets recover: “Because of 2008, I will require all clients with winning positions to trim away profi ts beyond the 20% mark from their original purchase point.” Advisor Mitchell Rosenberg learned from the tech meltdown in 2000 to sell when you’re ahead. “Bulls and bears make money, and pigs get slaughtered,” he says.

Utilize technical indicatorsSome advisors are fi nding room for technical analysis in their investment decisions, looking to moving averages and technical analysts who often signal selling momentum long before fundamentals refl ect downside risk. “I have learned that technical indicators have a place in our fi nancial advising arsenal and should be used in conjunction with fundamental analysis,” says Scott C., who is with a major wirehouse. “I also believe that industry truisms such as ‘buy and hold’ will not work in the current market, and possibly over the next fi ve to 10 years.”

Seek broader diversificationStandard diversifi cation failed to stanch client losses in 2008. Advisors began to question the basis of modern portfolio theory that calls for allocations to stocks and bonds. “I thought I was protecting my clients adequately by spreading their equity allocations across U.S. stocks, foreign stocks, real estate, and commodities. That strategy worked well for decades, but it didn’t work in 2008, when all asset classes, including most bonds, collapsed,” reports Robert C., who is with a major regional fi rm. Advisor Mike H. agrees: “Flexibility is key. Alternative asset classes are more important than ever.” Advisor Chris N. adds, “When you don’t have discretion, and even if you do, you should utilize ETFs, commodities, short funds, fi xed accounts, equities, and annuities. And don’t forget to hedge your holdings with options.”

Hedge your betsOften it’s the advice you don’t take that haunts you. An advisor with a regional fi rm regrets not listening to his hedge fund manager friend’s advice. “A friend who left my fi rm a year ago because they would not let him block trade started his own hedge fund. He called me in early summer 2008 and said, ‘Go to 75% cash and use these eight ETF shorts for the rest.’ I’m like, ‘Are you freaking nuts?’ Well, his client just sent him a note saying, ‘You saved my life. Here is another $35 million.’ Meanwhile, I put my clients into a warm-fuzzy-safe preferred with Fannie Mae and my fi rm’s ‘special forward-thinking’ mutual fund programs (down a mere 40%), and I anticipate a nice long year of arbitration. Yippee!”

Look outside capital assetsFor some advisors, 2008 taught them to think beyond classic asset allocation to a broader array of investments for their clients and their own assets. “I think after this mess that I am going to invest some of my capital outside of the traditional stock and bond market, such as a business, apartment buildings, more education, something where I have more control,” says Kevin D., who is with a wirehouse. “I often wondered why small-business


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owners always seem to invest in their own business instead of stocks and bonds. It is because if they make a mistake, they have no one to blame but themselves. While working for a wirehouse or franchise, CEOs or managers make mistakes or bad judgment calls, it still hits you in the pocketbook, and you have a little or no input. I have learned a lot from this.“

No hedges work all the timeThe move to absolute return vehicles and commodity investments don’t always protect you from loss. Glenn G., in Wailuku, Hawaii, advises: “I did begin to get my retired and soon-to-be-retired clients out of the markets in December ‘07. I positioned half of their assets into alternative investments, including commodities and absolute return investments. The absolute returns are down 20%, and commodities tanked. My advice is to always have lots of cash on hand, use more variable annuities, and stay close to your top 50 clients.”

The value of active managementDespite the diffi culty of timing the market, active management can pay dividends. James B., in Dubuque, Iowa, says, “I entered the business in 1979. I have always embraced active asset allocation strategies, despite some relative sluggish performance in the late 1990s. My clients had positive returns in 2000 and 2001, with very minor losses in 2002. We did well (better than the S&P 500) from 2003-2007 and we were in cash for most of 2008 (down about 4% for the year).”

Another advisor explains the value of market timing: “The primary purpose of market timing is not trying to pick highs and lows, which is virtually impossible, but reducing risk to a level where one can stay with the investment plan and not have to wait years for stocks that ‘always come back’ to recover losses of 40%, 50%, 60% or more. Simple trend following works.”

More advisor lessonsRegarding taking defensive measures, advisors say:

“Hope that markets go up should not be the basis of one’s business strategy.”•

“Mutual funds that invest in ‘fi xed income’ should be renamed variable income • funds. CDs and bonds have fi xed incomes and maturities—funds don’t.”

“Exotic investments such as Auction-Rate Securities (ARS), hedge funds, Credit • Default Swaps (CDS), and Structured Investment Vehicles (SIVs) are for the benefi t of the issuer, not so much for the client. Simple is better.”

“Industry-specifi c funds tend to blow up at some point. As an advisor, it’s too • diffi cult to move in and out. I buy generic funds and let the manager decide which industry to emphasize, if any. Then you can grade the manager for your client.”

“There are several aspects to a secure fi nancial situation. We must consider all of • them: income, expenses, cash fl ow, debts. The value of a client’s investment account is just one factor.”


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“There is a dramatic difference between an accumulator and distributor. • In the industry, we sometimes take excessive risks with our clients that are distributing.”

“I will make available enough cash or cash equivalent as my insulation for • market drops. I need to be vigilant about getting clients to understand their ultimate fi nancial goals from our fi rst meeting, either as a reminder on a document they sign or from notes I put down on contact management system.”

“It is very necessary to protect the downside. Here in Canada, it is diffi cult to do • this in retirement accounts, as minimum percentage withdrawals are required every year and the percentages are relatively high. So, utilizing fi xed-income solutions means eating into capital immediately.”

“I am in maximum risk management now and anticipate that for at least the • next 12 to 18 months. It will be three to fi ve years for the earnings cycle to be on the upswing again. The decision on where to put money now is very diffi cult. Nothing looks good to me. We are using some bank CDs, selective munis, and precious metals. The investment paradigm has changed forever. Trust will be slow to come back. It is not the end of the world, but it will look a lot like it.”

“I am recommending that clients are in disaster-preparedness mode—cash on • hand, food and water, protection, maybe some cigars (seriously). This is not about freaking out—it is about being realistically prepared for the tough times ahead.”

“If you really want to protect in an emergency scenario, a few thousand dollars • of cash in a safe at the house is worth discussing, as well as self-protection items they are comfortable with. One of my clients has a neighbor storing guns and ammo, which is appropriate for the geographical location they are in and for their experience. For some people guns would not be appropriate.”

“Jesse Livermore was right—Markets are never wrong, only opinions are. So make • sure you take losses when your stocks drop 10%-15%.”

“Do small things if you can to the portfolio that will help them. Example: Buy • a good-quality bond with good yield. It helps them know that you are watching their portfolio and ‘doing something’ that may help them.”

“I’ve learned that balanced funds are not bond funds and that distributions • should be taken from liquid assets with little to no volatility. Great balanced funds can go down 25%. We have consistently said we need to keep three to fi ve years’ [worth] of money liquid for distributions in retirement. However we leaned a little too heavily on balanced funds to fulfi ll our 40% or 50% of bonds in a portfolio.”

“When the VIX gets back under 30, then maybe normal investing makes sense. • Get creative—real estate (not REITs), actual properties is looking good now.”


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Other truisms:

Take profi ts—you will need them•

Don’t catch falling knives•

Diversifi cation matters•

Patience pays•

Plan for the worst; hope for the best•

SUMMARY

Advisor Vivian C. summarizes it this way: “You cannot be over-defensive if your objective is wealth preservation. This might be a trader’s market rather than an investor’s market for some time to come, in spite of what Bill Miller at Legg Mason might say. You need to collar your equity positions and take small bites (of return) as you go along. The fi nancial stocks (beaten-down banks) offer unprecedented opportunities for the long, long run.”

Heading into an unknown future, advisors will have to be more nimble than ever: willing to respond more rapidly to market movements and hoping for the best but planning for the worst.


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With fee and commission revenue down, many advisors were forced to pay more attention to their own fi nances, including cash fl ow and their own retirement plans. They looked to trim business and personal expenses heading into 2009.

“I learned I was very casual about spending money in my business,” says Beth Blecker of Eastern Financial Planning in New York. “I saw how much I bought that I never used or never read, including software I never used. So as part of my 2009 budget, we reviewed last year’s expenses and instructed my staff on spending and price control. Now they do not just buy business supplies—they price them and buy things on sale and things we really need.”

Keeping fi xed costs low is key, according to Dexter W. of Dennison, Texas: “Always keep a close eye on expenses, especially the recurring ones. A one-time expense to save costs or increase service is usually less destructive than an ongoing monthly charge.”

Plan ahead for downturnsWhile advisors looked to trim costs, they extolled the value of an emergency fund, just as they urge clients to do. Dexter W. adds: “I keep enough in bonds and money markets to fund an entire year of personal and business expenses. I develop an annual business plan. This allows me to estimate how much a 10%, 20%, or 30% decline in the market will affect my bottom line. I can then make strategic adjustments, rather than living from commission check to commission check.”

Create a balanced practiceMark C., in Irvine, Calif., recommends balancing revenue between commissions and fees to create a diversifi ed income stream. “I am primarily a life producer whose income is based on transactions,” he says. “While I have only been slightly focused in the AUM arena, my counterparts have told me for years I’ve been missing the boat and to get on the ‘recurring-revenue’ bandwagon. I believe that the fi rst lesson for fi nancial advisors is

Get Your Own House in Order

Lesson #4

“The fi nancial crisis of 2008 caught me completely unprepared.” —Luis H, San Antonio, Texas


24 |

to have a balanced practice that has a high degree of recurring revenue combined with transactions that go right to the bottom line. This combination, I believe, provides the best insulation from a downturn like the one we fi nd ourselves in today.”

Pay attention to your own retirement plansSome advisors had to postpone their own retirement as a result of the downturn. “The fi nancial crisis of 2008 caught me completely unprepared,” says one advisor. “I thought I was set to retire in the next three years. Now, after a loss of half of my investments and losses of my clients, my plans for retirement have to be extended.”

More advisor lessonsTo be personally prepared for a downturn, advisors say:

“Prospect like there’s no tomorrow.”•

“Be sure to have your own fi nancial house in order, with plenty of cash to • weather the storm. I have no personal or business debt. I want to be here when this thing turns around.”

“Take care of yourself. Exercise, get enough sleep, eat right, and tell your family • how much they mean to you. This pays huge dividends.”

“Take good care of your staff. Reward them and compliment them often. Tell • them that you couldn’t do it without them, because you can’t. They are your lifeblood. They make you look good and watch your back. If they are relaxed and feel good about themselves, they will pass that feeling on to your clients when they call or come by. A good book on this is The One Minute Manager. You can probably read it in an hour.”

“Remember what is important in your business—communicating proactively, • staying open and listening, being a sounding board, and keeping your information sources varied.”

“Remember, the markets are not life and death. Family, health, and faith are just • as important as assets under management.”

“Clients that don’t listen to you or take your advice should be gently counseled • out of your practice (they will be nightmares next time around).”

“Stay humble.”•

SUMMARY

Advisors who followed their own advice to clients by keeping an emergency fund and reducing debt weathered the downturn. As one business consultant said: “This is going to be the greatest shakeout in the industry’s history. Only advisors who are mentally, physically, and fi nancially tough will survive.” And those survivors are learning that the shakeout in the fi nancial advice business represents an excellent time for prospecting for new business.


| 25 | 25

For some advisors, 2008 was the year they realized they were selling buggy whips in the car era—or going long-only in the short age. In the face of a severe downturn they didn’t expect, advisors were faced with the choice of insisting that their opinion of what should be happening was right—or

accepting the wisdom of famed short-trader Jesse Livermore: “Markets are never wrong.”

Many advisors began to question the basis of modern portfolio theory as correlations continued to synchronize, and in many cases failed to diversify. Advisor Bob Chesapeake of Woods Financial explained the larger shift in his thinking: “All of the past models, the economic indicators, the means by which we measured markets and trends, are to a large extent now obsolete.... We need strategies for exits and strategies for disbursement and the willingness to, if necessary, actually go to an ‘assets not under management’ strategy when it’s in the best interest of the client. The tools are available and appropriate even though they might not generate ongoing revenue. We owe our clients that honesty.”

Advisor Bruce Kahn of the Foundation Group adds: “Successful entrepreneurs must update their business plans and products. The old investment pie chart is no longer a valid measurement of succeeding. The certainty and longevity that existed in past investment models is gone. We all must analyze and change our advice and investments consistently.”

Another advisor concurred: “This will be unlike anything we have ever seen. I believe that as a society, the excess debt built up through greed will take years to unwind, clear out, and renew.”

Constantly reevaluate your approachMany advisors are trying new strategies with clients and revising their own plans. “I have learned to walk through a risk tolerance questionnaire with every client, even those I’ve had for 20 years, to have a record of their responses in their fi le,” says a wirehouse advisor. “I now insist that clients fi ve years away from retirement start to shift more assets into

Be Open to Change

Lesson #5

“The problem with downturns is that what is normal is not. You can’t play by the rules if they don’t exist. So, in the meantime, look for other ways to make your clients money and keep it safe.” —Steve G., Huntington Beach, Calif


26 |

bonds/cash, even if the market is hot and they want to stay 100% in equities. And I’m now encouraging clients who describe themselves as aggressive but are age 50 and above to have at least 20%-30% of their portfolio in bonds. A lot of our clients have been aggressive up until this point, and are now realizing they can’t take the volatility.”

Advisor Joel G., in Springfi eld, Ill., has changed his view of risk: “All asset classes, even those that we consider to only have a trace element of risk, are capable of downside losses that far exceed historical expectations. This current economic scenario will create a paradigm shift in how the investment world recognizes and measures risk.”

Need to be nimbleMany advisors learned that they can no longer afford to wait out storms—the risk to clients is too great. Jeffrey K., in Mequon, Wisc., says, “I have learned that while you can have a great relationship with your clients, very few people can tolerate a percentage drop as we have had. Clients do expect the broker to be their ‘market timer’ and ask, ‘Why didn’t you get us out?’ What I have learned is that buy and hold is not the best strategy. With 10 years of gains destroyed, I wonder if I will be in business next year after 22 years in the business. These last few years remind me of the mythological fi gure Sisyphus, who had to push the rock to the top of the mountain, and as he gets near the top, it rolls down and he needs to start over.”

More advisor lessons“The world is in constant fl ux. The universe is made up of energy and atoms that • are always moving. Life is part of the universe, and so is business.”

“Business models and demands, because of technology and computers, are • changing at a faster rate than ever before. It took the buggy whip manufacturer a much longer period of time to see their product slip in sales than it took Washington Mutual to fi nd themselves virtually out of business overnight.”

“Those who do not change will end up extinct and out of business. Those who do • change will end up on top of their games if they make the right decisions.”

“The certainty and longevity that existed in past investment models is gone. The • good news is there is a world of new paradigms that can create opportunity and wealth.”

“I used what I learned from the NASDAQ bubble of 2001-2002. My broker-• dealer was telling us to tell our clients to ‘just ride it out.’ I had some unhappy clients. I am now independent from that. I started taking my older clients out of the market over two years ago and all of my clients out on September 29 and 30, when I saw Lehman, WaMu, and AIG begin to fail.”

“Markets are no longer effi cient as a result, I believe, of the unrestricted • and injudicious use of derivatives. Reregulation is required, and none of the politicians are addressing this issue. The proof of this hypothesis is what happened when the SEC removed the short-selling ban on fi nancials in the U.S. Virtually every stock was attacked immediately.”


| 27

“Buy and hold is fl awed from the start—fl exibility is key.”•

“Alternatives are more important than ever.”•

“What this market turbulence has taught me is that conventional wisdom (buy • and hold) is not 100% reliable. I support buy and hold as a base strategy and going forward will implement a satellite process that monitors positions that go against me.”

“If you are not willing to embrace new strategies for the future and continue to • stubbornly stick your head in the sand when it comes to the new thinking and new concepts, then you can’t complain when I or someone like me comes in behind you, recommends some of these new ideas to your client, and acquires your business.”

“People will need more information and/or advice to prosper in the upcoming • years. Long-term do-it-yourselfers will become frustrated and will seek the advice of professionals.”

“We are all in the survival business.”•

“When the 200-day moving average is broken, beware.”•

“The previously unimaginable must now be imaginable.”•

“Those who believe in the conventional wisdom will continue to spout the same • wrong thinking.”

“We have learned that nothing goes up forever and that greed will most certainly • lead to a decline of our current state.”

“Stock picking is making a comeback. Strong dividends, quality companies in a • portfolio that you control—what a concept.”

“Staying conservative and actively managing outside of mutual funds is better • than just being a ‘face in the crowd.’”

“No matter how well you think you are doing, the market can still throw you a • curveball.”

SUMMARY

One advisor summarizes the need to change this way: “The last year has taught me that nothing is certain. The best fi nancial plans are not permanent, and they need to be revised when circumstances change.”

Advisors who are open to change will be more receptive to new ideas in a changing investment environment.


| 29 | 29

The more things change, the more they stay the same. Proactively reaching out to clients was as important as ever in 2008—especially given new studies that show clients won’t always call you when they’re dissatisfi ed; they’ll just badmouth you to everyone they know. While it’s much easier to call clients

when their accounts are up 20% rather than down 20% (or 40%), advisors knew they had to keep communicating.

“Most of my clients have not been calling me, but when I reach out, they have plenty to talk about,” reports Debbie Charpentier, with Lincoln Financial Advisors. “I’ve been taking small groups out to casual lunch, rotating the people I invite, including prospects, friends, and clients. We all are just commiserating [about the market] and making new friends. This is really working well for me.”

Clients handle losses much better when they know you are still on top of their fi nancial situation and taking time to educate them on what’s happening in the market. Advisor Jeanice H. says, “While my clients don’t like what is happening, they understand the market better because we took time to manage their expectations, never focused on performance, and treated them like the important people they are. It is an unending responsibility because it has to be reinforced often.”

Daily client retention efforts neededOne of the biggest mistakes advisors make in a severe downturn is to stop reaching out. Inaction harms relationships, which can lead to defections. “It’s imperative to stay in contact with clients,” says Dennis W., in Meadville, Pa. “It’s one thing to call or meet with them when the markets are on the rise, but as diffi cult as it is, it’s an entirely new ballgame to keep in close touch when so many of them are getting their heads handed to them. My offi ce manager says I’m ‘holding hands’… I prefer to look at it as ‘client retention.’”

Keep Communicating With Clients

Lesson #6

“Keep communicating. Your clients want to hear from you. They know the news is not good. They are looking for a plan for what to do next.” —Joseph O., advisor


30 |

Adds Beth Blecker: “I was doing well staying in contact with my clients, keeping them informed, and meeting with them often. So although we lost money in fees, we lost very few clients. We moved our A clients up to monthly meetings, and everyone else is quarterly. We are doing workshops, conference calls, and in December we had one of our mutual fund money managers come to talk to our clients. We also send out many e-mails and/or snail-mail updates and hand-holding letters.”

Differentiate yourselfAdvisors in 2008 learned that despite going through a tough market environment, it was an excellent chance to separate themselves from other advisors who weren’t reaching out to clients—a golden marketing opportunity—even to existing clients. “Today too many advisors are just calling when they are selling, not advising,” says Edward S., in Pittsburgh, Pa. “Separate yourself from these by doing goodwill calling. Ask clients and prospects about their kids, and if they saw the article you sent them. Let them know you are concerned about their best interests and you are working as a team. It’s so important to be available to discuss the economic situation and how it relates to their goals. Call them to reassure them you are aware of the fi nancial markets and that you will continue to keep them informed and will adjust their positions if needed.”

Consider a client councilIn addition to contacting clients about their goals, ask them about how you can do a better job and attract new business. Mark C., in Irvine, Calif., says: “Now is the best time to gather together your best clients and form a ‘Client Advisory Board.’ We just had our fi rst meeting last fall, and it was a complete success. Together, they helped outline a roadmap for our future by telling me what was most important in their eyes in the next 10 years. After 25 years in the business, I fi nally executed on this and I’m glad I did. We had our second meeting in January to present our ‘makeover’ and get their feedback and buy-in.”

In reaching out to clients, advisors say:“Clients want to know you are concerned, not scared. You may be excited about • the opportunities ahead, but you should validate their current fears.”

“Listen carefully to your clients. When they start raising concerns, their risk • tolerance is going down. Raise cash early.”

“Keep communicating. Your clients want to hear from you. They know the news • is not good. They are looking for a plan for what to do next.”

“Client contact over the years is extremely important when times get tough so • you have built trust.”

“Stay in touch with clients. Send notes, mailings, and articles. Keep it simple, • easy to understand, and something that they do not know. Call and just say hello—ask how they are feeling, reassure them that it will end, and show appreciation for their patience. It is the constant contact with valuable advice and informative news that builds trust.”


| 31

“Focus on the solution and the end result with clients rather than rehashing • all the agonizing problems. Clients look to you for guidance and for calm in the midst of the storm. Be available, accessible, and let them know you feel their pain and are in the same boat.”

“Stay in contact with clients, [and] admit to uncertainty and your change • in strategies as soon as possible. Listen to how the client is impacted both fi nancially and mentally, and act now with boldness even if it’s to say, ‘I abandon our previous strategy.’”

SUMMARY

You can never over-communicate. If you don’t call your clients often in a downturn or recession, they assume you don’t care or that you have lost confi dence in your investment advice. Advisors in 2008 learned to communicate often and offer concern, reassurance, and new information to allay the fear. They learned that communication is critical to survival.


| 33 | 33

Many advisors feel guilty for their client losses in 2008—despite the market being out of their control, and despite their best efforts. It’s comforting to realize, however, that clients, if left to their own devices, likely would be even worse off. Your job as an advisor is to help clients reach their goals

and to help them avoid major pitfalls. Nobody said it would be easy. And nobody said you’d do a perfect job. The market crash is an excellent opportunity to reevaluate your approach and to commit once again to becoming a student of the market. Learn all you can, from as many sources as you can. Talk to other advisors about what’s working for them in their investment approach. Don’t be afraid to learn new tricks—even if you’ve been at it awhile. Don’t be afraid to be a contrarian. And these days, being contrarian may just mean being an optimist.

While many advisors are changing their approaches to adapt to a new paradigm, some optimistic practitioners believe that the market—and conventional wisdom—will eventually prevail once again.

Brad B., of Raleigh, N.C., summarizes it this way:

There is no doubt this is a very challenging time that certainly makes us question some traditional investment views. However, I don’t necessarily think that just because we are experiencing a severe market downturn that we all of a sudden should change our entire investment philosophy or strategies for our clients. I think all of us in this industry know that loss is possible in the stock market. I think all of us in this industry know that there is no guarantee on how large the losses could be. I think all of us knew that greed and dishonesty exist, not just in this industry but any industry.

Therefore, do we really know anything different now than we knew before? Isn’t risk the premium we pay to be in the market? Then why is it now so much more important to change strategies? I still very much believe in many of the same investment fundamentals that have proven themselves over time—buying quality investments, and proper allocation. Of course, an S&P 500 Index fund won’t cut it as the last 10 years have shown us. But along with this, I think more than anything, this market tells us that we’d better know the client, the client’s

Conclusion


34 |

objectives, the client’s situation, and whether they can afford to invest or not. And we need to communicate with them regularly, not just in diffi cult times.

By learning the lessons from the Market Crash of 2008, you’re that much more prepared for next storm—and the eventual break in the clouds.

| 35

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