In lean times, advisers earn their stripes

The investment adviser’s job has never been more difficult. The stock market is highly volatile. The economic recovery is on the verge of stalling — perhaps indicating still lower stock prices ahead. In addition, U.S. investors are concerned about a Greek default and its impact not only on the European banks and economy but also on U.S. banks and the domestic economic climate.

Some fear that the market could head down toward the 2008 bear market levels.

Congress is gridlocked over the appropriate steps to help the U.S. economy, and the Federal Reserve is trying to stave off a double-dip recession with easy money, which weakened the dollar until the Europeans became gridlocked over helping Greece, thus weakening the euro.

Now, when clients need advice more than ever, and they are worried about being able to meet their future income needs from their savings and investments, the old verities of investing seem to have been challenged.

TIMES HAVE CHANGED

For many years, investors nearing retirement were told that they should be able to withdraw between 5% and 7% of the value of their portfolios each year to live on without affecting the value of the principal.

That no longer seems possible, as it was based on the historical long-term returns in the stock and bond markets, and a portfolio appropriately balanced between the two.

Although bond investors have prospered in the past decade, as interest rates have fallen, stock investors have suffered.

Indeed, many investors, after 10 years of no real return in the stock market, are on the verge of giving up on stocks.

Some are fleeing to the apparent security of Treasury bonds, even though the return on the 10-year Treasury is minuscule by historic standards. These investors have decided that return of investment is at least as important as return on investment.

But now, long-term fixed-income investors face the daunting task of reinvesting the principal from maturing bonds in their portfolios. The yields available won’t support a 5% withdrawal rate without drawing on the investor’s capital.

Further, there is the high probability that bond investors will suffer principal loss if they reverse course when the Fed finally halts its easy-money policies and allows interest rates to find their natural level.

Investors were told one secret to long-term investment success was diversification. Nobel laureate in economics Harry Markowitz once described diversification as the only free lunch in investing.

But building diversified U.S. stock portfolios hasn’t helped. Even diversifying into non-U.S. stocks and bonds hasn’t protected investors, nor has investing in commercial real estate.

Having U.S. bonds in the asset mix has helped, but it is fraught with danger over the next five to 10 years.

WHAT TO TELL CLIENTS

What should an investment adviser tell a client who wants to get out of stocks and into bonds at this time? Is it too late?

Should the investor simply move totally into cash? Who will tell the investor when it is time to move back into stocks and bonds?

What should a financial adviser tell clients who have gains in their fixed-income portfolios? Should the clients harvest those gains and invest them in money market instruments until the outlook becomes clearer, or should they continue to take their interest payments and allow the bonds to mature?

The answers to all these questions will, of course, be different for each client, depending on age and circumstances. However, one thing remains constant — clients are looking for guidance and reassurance, and advisers must have well-thought-out answers to these questions.

They must have answers that not only protect the clients’ long-term interests but that reassure them in the short run.