What Financial Advisors are Telling Their Clients Today

Episode 113 of the Investopedia Express with Caleb Silver (November 21, 2022)

November's burst of buying in the stock market slowed last week, as all of the major averages posted losses, but nothing too dramatic. The Dow ended about 0.1% lower—basically flat. The S&P lost less than 1% for the week, while the Nasdaq ended 1.5% lower. All three indexes are still positive for the month, and well off those October lows. But steeper inversions in the U.S. Treasury market are warning of tough times ahead. The full U.S. yield curve inverted last week, with the one-month Treasury bill yield rising above the 30-year Treasury bond yield. The last two times that happened: August to September of 2019—which was followed by a recession beginning in March of 2020, and August 2006 to August 2007—which was followed by a recession that started in January 2008.

Investors are looking for some solid footing and consistent messaging from the Federal Reserve as to the path of future rate hikes. And what we got last week from several Fed officials is that the path to the central bank's terminal rate remains pretty steep. St. Louis Federal Reserve President James Bullard said Thursday that the policy rate is not yet in a zone that may be considered sufficiently restrictive. According to Bullard, the appropriate zone for the federal funds rate could be in the range of 5% to 7%, which is higher than what the market is pricing.

That's the first time we've heard that 7% number for the terminal rate from the Fed, and looking at Fed fund futures from the CME, traders did not have that higher range in their forecasts. The highest target range is between 5% and 5.25%, which traders expect to occur by May of 2023. That mismatch of expectations may have led to some of the selling we saw last week. Inflation is cooling, to be sure, but maybe not fast enough for the Fed, which doesn't want to be perceived as behind the curve yet again.

Charles Schwab is out with its latest trader sentiment survey for the fourth quarter, and there are more than a few signs of optimism in trader land. Keep in mind—these are traders, not necessarily long-term investors, but since they're putting money to work more frequently than a lot of us, it's worth paying attention to how they feel. Some key takeaways from the survey? Sixty-eight percent say they are still bearish in the fourth quarter, but they still see opportunity in the energy and healthcare sectors, as well as value stocks. That jives with what we have been seeing in terms of market performance lately, and what we might expect given concerns about a recession.

To wit, nearly all respondents feel an economic recession in the United States is at least somewhat likely, with many suggesting it will begin, or has already begun, in 2022. Rising interest rates, inflation, and political issues—both domestic and international—are their top concerns, which kind-of sounds familiar. These have been the dominant walls of worry in our reader sentiment surveys and just about everybody else's.

Over half of those traders expect the Fed to increase interest rates by at least 50 basis points (bps) at the December meeting this year, while most respondents expect interest rates are unlikely to drop in 2023. Fed officials are insinuating that rates are headed higher for longer than Fed fund futures suggest, and that tug of war between hopes and expectations, versus the realities of what it's going to take to bring down inflation to the Fed's target rate of around 2%—that's the impasse we may be feeling in the U.S. equity market lately.

What's in this Episode

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We are big believers and champions of financial advisors here at Investopedia. We celebrate the most influential financial advisors in the country every year, through the Investopedia 100. That's our unique list of those independent advisors who spread financial literacy, education, and insights to their clients, their communities, and throughout the industry. And you are about to hear from several of them, from Schwab's Impact Conference a few weeks ago. Our team interviewed several advisors and investing professionals about what their clients are asking them about these days, their biggest worries, and how they are generating returns or protecting their clients' returns in this challenging market, plus their expectations for 2023.

You're going to hear some common themes: inflation, the bear market, the mess and opportunities in fixed income and alternative assets, but the common denominator among all advisors and their clients is having a financial plan. I consider myself pretty knowledgeable about investing and personal finance, but I didn't know what I didn't know until I signed up with a financial advisor, and it has been one of the smartest investments I've ever made. Here are some words of wisdom from some terrific financial advisors and planning professionals at the Schwab Impact Conference:

James: "James Demmert, managing partner and founder of Main Street Research, based in New York City, with offices also in San Francisco."

"Most people are asking me, "how long will this bear market last?" We've been saying for the last week or two that it's about two-thirds over. Stock prices really haven't come down as far as they probably need to, given the Fed's aggressive rate hikes and their adamancy about putting inflation back in the barn. It's going to be more tightening, and the equity market's just not ready for it, but it's getting there."

"All of our clients share one thing in common. We're managing the bulk of their liquid net worth, and most of them are worried, saying, "Hey, I want to make sure this money lasts the rest of my life." And then there's the other lucky half that say, "Hey, I want this to last my life with the next generation." We also manage money for foundations and nonprofits, and they need it to last for generations. So difficult markets like these can make people concerned about the valuation of their portfolio, which is why it's so important to manage the downside risk as we go through this."

"It's the first year that we've really seen fixed income—if you own a bond fund, for instance—fall pretty dramatically, almost more than stocks in an average year. So the 60-40 portfolio, conventionally done, has not worked out. For our firm, we use individual securities. We use individual bonds, so we really haven't had the downside that the bond funds have certainly experienced this year. And we think that the 60-40 portfolio is alive and well, even though conventional wisdom says it isn't, based on recent performance."

"In a market recovery, in an economic recovery, which we expect in 2023—this is a great opportunity for investors to lock in those 4% yields on two-to-10-year Treasurys, or on any other individual bond, a corporate or a muni—that'll make a great complement over the next five years or even ten. You do that on the bond side, and that'll compliment the great equity recovery that we're going to see in 2023. So 60-40 is going to be alive and well as we get past this bear market."

"Protecting portfolios is probably, in my opinion, the best way for advisors to add value. Bull markets are easy—we all know that. It's the bear markets that are difficult. And I would suggest three things that all investors should do in these kinds of markets, and it's still not too late. And one is: stop setting and forgetting the portfolio at 60-40 or 70-30. When it starts to look ugly—for instance, this year, with the Fed getting aggressive, which is not good for the economy—be willing to reduce your stock exposure. That's the number one way to manage risk. It doesn't have to go from 70% to zero, but anything less than normal is really prudent in this kind of market, and that's how we look at it."

"The second thing is—if you have to have stock exposure, be selective about it. We all know when the Fed raises rates, the economy contracts. Pick sectors of the market that tend to do well in that sort of environment. Healthcare is a good example—people are always getting ill, and we have health care products to help them. Consumer staples, like Procter and Gamble, that sell Tide detergent and Crest toothpaste—we're going to continue to use those, and utility companies as well. So rotating to the sectors that are defensive, and having less stock in general, is the key."

"And the last thing that we do that's very unique is we use very carefully-placed stop-loss orders. So when markets get like this—back in February and March, some stocks just got sold by the stop-loss, which in hindsight was a very helpful tool for us as we went through the year. All three things really help. We call it active risk management, but it helps mitigate that risk."

Helen: "Helen Stephens, Aspen Wealth Management in Fort Worth, Texas."

"I think the top worry is the possible length and severity of the current bear market, and how that's going to impact their retirement spending, for those that are retired. And inflation, and how persistent it's going to be and how long it's going to last. Well, we haven't abandoned our traditional strategies, as we feel like there's a lot of value to be found there."

"Short-duration fixed income has certainly provided a lot of portfolio protection, but we have allocated more toward private credit and private real estate as good diversifiers for our portfolio. It's not like they're completely protected from market decline, but there's just a considerable time lag until it starts to show. Certainly, tax-loss harvesting has been a busy task for us this year, in this down market, accelerating Roth conversions, and that has provided sources we think of as advisor alpha."

"We're continuing to focus on what we can control, not on what we can't control. Financial plan reviews have been more impactful for our clients than portfolio reviews. They just want to make sure that they have the peace of mind knowing that everything is going to be okay. Clients overall know the short term noise in markets will subside, and overall, they're more interested in how their portfolio affects the future in context with the changes in their lifestyle expenses, their savings, and how long they plan to keep working. So we're really focused right now on the financial plan and not so much the portfolio review, because everybody has a plan, and that plan is determined by how they're allocated in their portfolio."

Rob: "My name's Rob Santos. I'm the CEO of Arrowroot Family Office. We're based in Los Angeles, but we have offices in Virginia, Michigan, and Northern California as well."

"A lot of our clients are prepared for market fluctuations like this. I'd say the harder situations are the newer clients—folks that just had cash and were just starting to invest into the market this year. I think the concerns are higher for them, because they didn't realize that some of these fluctuations would have come so quickly."

"I think the top worries have to be—can they afford to achieve their goals? Are they making the right decisions with their money, for their family, and for their future? So I think those questions are top-of-mind. When they read headlines and see what's going on in the markets right now—they're human, so fear becomes a big factor. And I'm sure that a lot of advisors that you're interviewing at this conference—a big part of what our work is, is actually more counseling and psychological than it is financial. And so it's great from our perspective, because these are the tools that we think we have the best handle on, and that we get to deploy in situations like this."

"What we're trying to do to be creative is to use alternatives. We have started to implement some annuity products, if that makes sense, for some people. Cash is king this year; it's the best-performing asset class. So there are actually higher-yielding savings accounts and certificates of deposit (CDs), that are now starting to provide retirees some income, albeit inflation is eating away at their purchasing power. But for peace of mind, it's a solution for them. So you have to be really nimble."

"And I don't think anybody can put a cookie cutter model across all aspects of clients in this market. It just doesn't work. We had a number of clients that had tens of millions of dollars worth of crypto, and we talked to them over a number of periods about diversifying and protecting their wealth. And to varying degrees of success, we had some folks that will just still hold these assets forever, for their die-hard beliefs."

"And then we've had others that did make some of those decisions, and we could do some creative things around hedging around those crypto positions, which were traditional finance tools that we're implementing into a new crypto world—selling calls, buying puts, to be able to protect them for this winter. So we try to add value where we can, and where it's feasible. But there has to be receptiveness on the other side from the client."

Peter: "I'm Peter Lazaroff. I work for Plain Corp., which is based in St. Louis, and I'm the Chief Investment Officer (CIO) there."

"I think the one question that is coming up most frequently is "how long is this bear market going to last, and are things going to get worse?" To which I usually respond—just with a simple look at history and averages, the average bear market downturn when there's a recession attached—and I'm going to take the leap that we're going to have a recession, or deem that we're currently in one. When you look at those downturns, they take about 18 months, on average, to bottom out. And the average decline, peak-to-trough, is 33%."

"So for conversation's sake, I'm not saying that that's what's going to happen, but it's a nice place to anchor expectations. So as of this recording, we're about ten months in. So if I'm speaking to a client, I say, "Well, maybe we have another eight months, another 12 months." From a personal standpoint, I think that we will eclipse that down-30% from the peak. And I let clients know that, but I also let them know that that does not change the way that I'm going to be investing their portfolio, because we've built the portfolio based on a financial plan that takes into account downturns occurring with a similar magnitude and frequency as they have in the past."

"And thus far, there's really nothing unusual, strictly from a data standpoint, about this particular bear market. I do think that people who are nearing retirement are very worried. They're worried about inflation, they're worried about when the bear market is going to turn, and they're worried if their plan to retire, particularly if it's in the next one-to-two years, is still sound. So that group specifically, I think rightfully so, is a little bit more nervous. Good financial planning, if you've been doing it for a while—again, you should have things in place that will allow you to maintain your financial plan despite the economy."

"For people below the age of 50, I would say that a bigger concern is inflation in general. And for people who are looking to upgrade the size of their house, or who are trying to sort out whether or not they can do an addition to their house—that's been a big talking point for people with executive compensation, like stock options. Most of those options are underwater. So that's another big talking point for the people who are in their 30s, 40s, and 50s, that we seem to be addressing a lot these days."

"Even if you know what events are going to occur, you don't always know how markets are going to interpret that. And here's a really important statistic—if you go look at the last 20 years of returns, 50% of the best days in the S&P 500 happened during bear markets. Another 34% of the best days happened in the first two months after a bear market. So you have to stay invested, because you aren't going to know when it's going to end. And if you wait until the "all clear" bell is rung, you've probably already missed out. So I think that's really the core message that we're trying to communicate to clients right now."

"I believe that a one-size-fits-all portfolio is dead, and I think we are now at an age of customization. Whether you are 60% stocks or not, the amount of customization that we can do, as advisors, due to technology, due to product offerings, and due to some better processes and learned experiences—I would say that you usually can point a client to the levels of customization. And yes, this bad period happened. Again, we planned for these bad periods, and now, forward-going returns are going to be better. Valuations are lower, yields are higher, and the building block of all returns is the risk-free rate of return."

"And finally, we have something on the risk-free rate that is resembling a return. Granted, it's a negative real return when you look at inflation, but I think it's reasonable to assume that sometime in the next 12 months, that inflation dips closer into that four-to-5% range. Even if it doesn't settle back below 3%, most of our client base remembers an era where inflation was between three and 5% for most of the time, with the past 15 years or so being a much bigger outlier. I think if we start seeing prices go up by 3%, it will feel perfectly fine to everybody."

"Going into 2023, a lot of what I want clients to understand is that the current starting point where we are in the market—it's not so much risky, as it is annoying. And you have to attach a human side to this—nobody likes bear markets—we know it's a part of it. We've coached our clients to expect them. But the big part of the drop, the big part of the risk has already happened. And that's not to say we couldn't fall further—as you heard earlier, I think we will fall a little bit further. But, as long as you think that three years from now, stocks will be higher, or even one year, two years from now they'll be higher—a lot of the risk is erased. The biggest risk is that you behave poorly. And, if you are willing to live through all of this, then it stops being risky and is simply more of a nuisance. It's a little more annoying is how I'd characterize this bear market now."

"And so I think that's the theme heading into 2023, as silly as it sounds, that we want to carry forward to clients. Bear markets are bummers, we knew they were going to happen, and we don't like them. We are going to be here to make sure that you don't make a mistake, because the choices you make in a bear market can define your ultimate investment success. And so, we want to make sure that everybody behaves, keeps their hands on the wheel, and their eyes on the prize."

Brian: "My name is Brian Vendig. My firm is MJP Wealth Advisors. We're located in Connecticut, with offices in Farmington and Westport."

"So I think everyone just has a little bit of a heightened anxiety for some of these unknowns, and we're trying to relate things back strategically to what someone's investment management program or process is, and how that relates back to their strategic intent as part of their lifecycle goals. Fortunately, with a majority of our clients, we've put together a sound wealth plan that takes into account that there's going to be volatility. Markets don't always go up every single year. So I think we've put some measures in place that have helped people get through this noise, so to speak."

"But now that we get information so quickly, I think the style and the behaviors of investors have changed. Investors have seen markets go down very quickly, like in March of 2020, and then bounce back very quickly as well. Unfortunately, being in a bear market, it's a little bit more of an elongated path, and investors don't have the same type of mindset now, that they might have had previously, based upon age or based upon where they are."

"So we've been very focused on real asset, real infrastructure types-of-investments. So for a while actually, we jumped on the bandwagon of renewable energy infrastructure investments, well before the Inflation Reduction Act was passed this year. That has shown to be a good alternative for fixed income. We've also been invested very heavily in private equity real estate, which has had favorable returns coming out of 2020, and also creates a lot of tax-advantageous income, going back to a client. We are also still focused on hedge funds that do really show that they can minimize volatility, and put up some numbers in light of a market being significantly down."

"At the same time, we're trying to educate our clients about other asset classes, because we get the questions about digital assets, cryptocurrency, so we're able to kind-of speak to that. But again, you know, that's obviously a more speculative investment and that's on a case-by-case basis. So we have been very active in our investment portfolio. So one thing that we've been preparing for, and thinking about the market moving forward, is just staying cognizant on risk, and relating that back to our to our clients' needs."

"We're also thinking about any upcoming tax law changes, anything that might come out of the midterm elections, from a planning point of view. And also knowing that there are certain laws that are on the books right now, which are going to sunset in 2025, 2026, whether that's opportunity zone funds, or whether that's estate planning topics. And I think at the end of the day, it's just trying to be proactive, to keep people informed of, you know, what's coming down the road, measuring it back to how they're managing their household, what's going on at work, are they meeting their living expense needs, and I think it's just an ongoing process of assessments."

Malcolm: "Malcolm Ethridge, financial advisor out of D.C., with CIC Wealth Management. We've got a couple of offices between Baltimore and Rockville, Maryland. I am "Malcolm on Money" across all social medias, and I am also the host of the Tech Money Podcast."

"Instead of asking, "What do we do? What do we do?" I've noticed clients, especially our longer-standing clients, are asking, "Is there something we should be doing this time?" Which is a unique way of asking, "Is this time any different?"

"And I think that's the really cool nuance that I've noticed with clients from March 2020, when the pandemic first came on, to even now, where the market seems to be working against us and has been for the majority of this year, where we can't run to fixed income for safety, the way we used to be able to, or at least in this particular market cycle, we haven't been able to. And so, looking at bonds and saying "that's the safety net, that's the place where we at least expect asset preservation"—that's gone, at least in this moment. And so we're having to be very creative about finding bond surrogates and things like that, to shelter clients from the storm."

"One of the things we've been focused on for 2023 is dissecting the portfolio to find out how much concentration we have in mega-cap tech, and making sure the clients are aware of the top ten holdings in their portfolio. So a lot of what we do is a blend between ETFs and mutual funds. And, as I'm sure you guys know, there's a lot of intersection in those funds, where every fund manager owns Apple because, if you want to beat the index, you got to own Apple—Apple is the index. Or if you want to beat the index, you got to own Tesla, or Amazon, and so on."

"And so, making sure that as this rotation, to value or to the small caps or to whatever else we see coming is happening, that we're not over-indexed to the mega-cap tech trade that got us here. For clients who are a little bit more conservative, maybe moderate-to-conservative, where they need to be more diversified and more balanced than their equity exposure, just in case that tech trade goes away and doesn't rebound with the rest of the market in the way it has for the last decade or so."

Term of the Week: Organized Retail Crime

It's terminology time. Time for educated investors like us to smarten up for the week. And sadly, this week's term comes to us from Target and other retailers, because the term of the week is "organized retail crime." Last week, Target executives said on the company's earnings call that inventory shrinkage, or the disappearance of merchandise due to organized retail crime, has reduced its gross profit margin by $400 million so far in 2022, compared to last year. Organized retail crime is not new, but it's gotten a lot worse in the past couple of years, according to the National Retail Federation (NRF). But what is it, exactly?

According to the NRF, organized retail crime is the large-scale theft of retail merchandise, with the intent to resell the items for financial gain. Organized retail crime typically involves a criminal enterprise, employing a group of individuals who steal large quantities of merchandise from a number of stores, and a fencing operation that converts the stolen goods into cash. Stolen items can be sold through online auction sites, at flea markets, and even to other retailers. In addition to targeting other stores, organized retail crime gangs engage in cargo theft activities.

According to the National Retail Federation's National Retail Security Survey, losses associated with organized retail crime reached $94.5 billion in 2021, up from $90.8 billion in 2020. The report also found that retailers saw an average 26.5% increase in organized retail crime incidents between 2020 and 2021, and they also reported an increase in violence and aggression associated with these types of crimes. We've seen the videos on social media, and they are terrifying.

But this is the new reality for retailers who are facing all kinds of other challenges, including inflation and more online competition. The U.S. Chamber of Commerce, among other organizations, is pushing for tougher laws to combat organized retail crime because, believe it or not, there aren't that many on the books. So for now, retailers have to consider organized retail crime as just another cost of doing business.

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  1. National Retail Federation (NRF). "2022 Retail Security Survey"

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