Advisors have been trained that there are two things they should never discuss with their clients, and they’re not religion and politics. We’re talking about risk and the short term.
All of our research points to a simple truth: while investors should be focused on the long term, they react to risk in the short term, and emotional reactions to risk are the #1 killers of long-term financial goals and results.
Let’s revisit a familiar conversation:
Investor: Wait a minute—I can’t just sit back for thirty years in order to find out if we were right! I’m at least going to need an idea about what is considered “normal” year-over-year for this portfolio.
Advisor: I completely understand. I can’t make any promises, but given our long-term perspective, this portfolio might make something like 8% year-over-year.
Sounds familiar, right? Here’s what happens next.
They shake hands, fill out the proper paperwork, and the client is officially invested! Fast forward to two months later: a merger between two companies the investor has never heard of causes a momentary shift and that 8% yearly portfolio is now -25% overnight.
An advisor can take the panicked phone calls and assure their client this fluctuation is temporary, but the damage has already been done. The client is scared, and their 8% promised return is out the window—through no fault of their own (or their advisor).
While this is certainly a worst-case scenario, downturns happen all the time and are short-lived, but why the insistence on keeping clients in the dark on the short-term? Sure, blips don’t affect the bigger picture, but what happens now matters in the eye of the investor.
While “hanging in there” is the best way to ensure investing for the long haul, it’s hard to go against human nature. Fear plays an important part in survival, and the trait carries over into all facets of life, including investing. Humans have greater motivation to minimize losses rather than earn gains. Simply put: losses hurt worse than gains feel good. It’s this ability to minimize risk to ourselves that makes us wonderful survivors—but less than ideal investors. Focusing on the long-term is a good overall strategy, but it ignores the fact that all long-term investors are made one short-term decision at a time.