Apples, Oranges & The S&P

I happen to share a trainer with a local advisor. I hadn’t seen him since early 2022, so when I saw him recently, I asked him how his clients responded to the minting of a bear market in U.S. equities.

He shared that he was satisfied with the planning and preparation he had done with his clients because it yielded constructive dialogue and (mostly) content clients. However, he did join me in lamenting over the change in how many clients evaluate success during a bear market versus a bull.

We joked about how, when things are going well, the phone doesn’t ring and clients are fine with the occasional update in percentage terms. On the flip side, when markets decline, clients suddenly become very attuned and only want to know how many dollars they have lost. In short, the benchmark to which a client compares performance changes.

In my opinion one of the biggest obstacles to investors achieving success, whether they utilize a financial advisor or not, is the practice of benchmarking.

Now, I’m not suggesting that benchmarks should never be used. Rather, I’m stating that applying a benchmark incorrectly can eventually lead to the same outcome as investing in something that declines in value. In other words, getting the benchmark correct, and sticking with it, is as critical as picking the right investments. 

Behavioral Finance Drives Shifting Expectations

Investors often have unrealistic expectations when it comes to investing in markets. They can waffle from a focus on return to a focus on risk.

Around the halls of Blueprint Investment Partners, we sometimes joke about how bull markets seem to entice investors to compare everything to the S&P 500 – or worse, the Dow Jones – while in a bear market everything is compared to a CD. Unfortunately, some financial advisors fall into this comparison trap as well.

This creates a challenge for the advisors and asset managers who serve them.

When emotions are high, personal biases take over. Few experiences are more emotional than feeling like you’re losing money. Sometimes that feeling comes from a factual place – such as seeing portfolio amounts decline during a bear market – and other times it’s a perception that account values aren’t increasing at the same rate as everyone else.

Tamping Down Volatility in Client Expectations

Having had the privilege of working with many financial advisors over the years, we’ve had plenty of conservations about how to deal with the ever-changing expectations of investors. The strategies that seem to rise to the top are:

1) Make sure you and your client are aligned about the end goal and the plan to get there. Then, document the plan somewhere so you can regularly revisit it. 

Neuroscience tells us that humans are much more likely to achieve a goal if it is written down. When reviewed over the appropriate timeframe, this can serve as a healthy anchor (and an appropriate benchmark) to put short-term results in perspective.

2) Develop and discuss stress-test scenarios.

To help establish the proper timeframe for evaluating progress, it is helpful to clearly communicate that periods of poor performance WILL happen – but proper planning before, and execution during, can be factored into the journey. Return and risk should be viewed consistently across the investment lifecycle. Stress testing exercises put this in a format that clients can visualize. Moreover, when these scenarios are documented, you can revisit them with clients when needed to help keep investors anchored to their plans.

3) Incorporate a repeatable, rules-based process that proactively makes changes in a predictable fashion.

The final piece can help further cement the odds of success by consistently making intuitive – and, importantly, EXPECTED – shifts in allocations that automatically respond to changing market conditions. Knowing what a strategy will do and being able to proactively communicate that to clients can be powerful tools to ease anxiety. This process is what drives Blueprint Investment Partners and its systematic investing strategies, for example.

Picking Appropriate Benchmarks – But Also Investments

I mentioned earlier my belief that getting the benchmark correct, and sticking with it, is as critical as picking the right investments.

I view these similarly because using an otherwise effective investment in the wrong spot in the portfolio can create a gap between the investment’s intended performance and the expectation of what should occur. This gap can lead to a sound investment being prematurely abandoned, which is rarely good for compounding.

We, like other asset managers, encountered this scenario in 2022. Despite generally outperforming appropriate benchmarks in both 2021 (bull market) and 2022 (bear market), there have been instances where clients have moved on due to perceived underperformance.

We’re upfront with financial advisors about how Blueprint Investment Partners strategies are intended to be used as a core strategy, or as a satellite holding or tactical allocation. We strive to make that clear because we believe in practicing what we preach, including the points above about making sure we’re aligned with our clients (advisors), sharing stress tests, and following a systematic investing process.

However, while these are the most common applications, we also see the Blueprint Investment Partners strategies applied in other ways, such as within absolute return or hedged equity buckets.

Keeping on the Path to Success

Whether in the context of benchmarks or investments, I think the following analogy – which actually came from a video the dad-version of me watched because it spoke to keeping your kids on a path to success – is a good way to close:

Keep your kids in the river between the two shores and though they may stray out of the best currents (or even paddle against them) at times, they will generally, eventually, reach the destination.