If there's one staple of financial planning wisdom that virtually everyone will agree upon, it's stocks for the long run. Sure, we all acknowledge that markets can be volatile in the short term, but we all seem to still agree that in the long run, stocks are still where it's at. So as long as you have a long enough time horizon - whether you're a young person still accumulating, or a retiree looking at a multi-decade spending phase - stocks are still a material portion of the portfolio. But within the past hundred years alone, there was nearly an entire generation - who grew up during the Great Depression - that gave up on stocks for their entire lives. What if that happened again? Has the financial planning profession hitched itself to the stocks-for-the-long-run wagon so tightly that if stocks fall off a cliff, so too will the profession?
Today's blog post is a subject I have been giving a great deal of thought to lately. As a profession, we seem to have hitched ourselves to the stocks-for-the-long-run wagon. The implicit expectation that stocks MUST belong in a portfolio is so dominant, it's almost impossible to even think of a world where stocks aren't the central portfolio focus. But what if stocks had a real disaster? What if we went through a second Great Depression for real, and another generation flat out gave up on equities? What if the US has a Japan-style experience, where the stock market is below half of its former peak over two decades later? If the S&P 500 is still under 750 in 2020, where does the financial planning profession stand?
When I pose this kind of stock market scenario to planners, many dismiss it outright as being impossible, but surely it's not; similar market events, and worse, have happened in other countries throughout the world. It may not be probable, or even likely, but to deny it's possible seems ridiculous; after all, we didn't think it was possible for housing to experience a bubble and a national price decline, until it did.
Alternatively, many point out "but if you don't invest in stocks, clients can never achieve their goals!" To which I have to reply, "rubbish!" (Or substitute a stronger word of your choosing!) People have accumulated sufficient wealth to live a sustainable life and retirement without the tailwind of equities for a long time now. Most of the Great Depression generation did it, through hard work, a much thriftier lifestyle, and a strong and steady focus on saving (in bonds and CDs!). Could we do it without equities the way we save today? No, certainly not; we'd have to save a LOT more. But can enough wealth be accumulated to sustain a successful lifestyle; absolutely.
But then again, that's the point. Financial planning has built all of its investing and spending recommendations around the saving that would necessary if we get the long-term stock returns we expect. If markets aren't just volatile for a year or few, but instead a decade or few, clients are going to find themselves with dire shortfalls; they may have earned market returns, but if the market didn't return what they needed, the financial plan itself is still a catastrophe.
Of course, it doesn't have to be this way. Financial planners could take a strong stand on spending less and saving more. We could focus more of our value on helping clients navigate tax, employee benefits, mortgages, debt, and other financial issues, instead of necessarily being as investment-centric as we are. But the point isn't even about our investment-centric business models; it's about our stock-centric investment advice, and the presumption that all clients should have a significant exposure to equities to benefit from their long-term returns. And we assume that the disaster event will never really happen.
But what happens if that event occurs? What happens if we take clients into the stock markets and they really don't generate much of any return - or worse, outright lose a significant amount of money - over a time period as long as 20+ years? Will clients forsake the market? All of history points suggests the answer is "yes", an entire generation may walk away from equity investing. But if the equity bear market also destroys their financial planning goals, does that mean clients will walk away from financial planning, too?
It seems unlikely, improbable, and almost impossible. But are you willing to bet your practice and the future of the profession on it?
Paul Puckett says
You raise many issues that have also been weighing on me as an author and investment advisor. I hope you don’t mind my responding in the comments section, but I believe these issues you are critically important. The role of financial planners, investment advisors, and brokers are vital to our client’s future.
There are several recent studies indicating that many investors are not currently in the market and do not plan to return. The Prudential survey shows 44% of Americans do not ever plan to invest in the market again. Our profession is responsible for reducing that number. Looking at investment returns for longer time periods is a starting point.
Here are a few thoughts on questions raised in your post:
“But within the past hundred years alone, there was nearly an entire generation – who grew up during the Great Depression – that gave up on stocks for their entire lives. What if that happened again?”
It may happen again, but the financial planning industry did not exist during the Great Depression and there were few professionals in the investment advisory and brokerage industry serving small investors. The public needs consistent and well-informed professional guidance to financially handle events like the Great Depression. We may not all share the same investment approach, but in my opinion, giving people what they think they want is not a solution that will help the profession.
When I got into the industry in 1987, it was normal to hear people say that it took over 25 years to recover from the Great Depression. Dividends were not considered in that calculation and it turns out it actually took 15 1/2 years for investors who were 100% invested in stocks. It took less time for those who had balanced portfolio’s.
Investors who were part of the generation that avoided stocks suffered financially as a result of their fears. Sure, they may have made up for their lack of equities by a higher savings rate but at a much lower return and less wealth than they otherwise would have accumulated. Incidentally, when I was a trust officer and a private banker, I did not see any high net worth clients who bought into the Great Depression as a justification for avoiding stocks. I also didn’t have any clients who became wealthy without equities with the exception of business owners whose sole equity exposure was their own company.
Stocks, as you know, represent ownership in companies. In any economic environment where stocks lose long-term, what asset class is safe? The financial planning profession is not making a mistake in focusing on stock ownership (typically through diversified mutual funds or exchange traded funds). If we know as professionals, the need for stock exposure in an investors portfolio, we must find ways to keep investors invested regardless of market conditions.
That may sound difficult, but would it be easier to increase the average person’s savings rate?
“What happens if we take clients into the stock markets and they really don’t generate much of any return – or worse, outright lose a significant amount of money – over a time period as long as 20+ years? Will clients forsake the market? All of history points suggests the answer is “yes”, an entire generation may walk away from equity investing.”
Preparing clients for the possibility of loss, even long-term, is critical. It demonstrates the reason why putting everything in one asset class is not prudent but it does not indicate stocks should be avoided. Our focus should be on finding ways to keep investors in the market regardless of conditions.
We should be more like the medical profession. If a Doctor were asked if it is possible to lose weight while avoiding vegetables and eating donuts, they would probably say no. Or they might say, it’s possible, you would just need to run a 10k every day. The medical profession provides consistent nutrition and medical advice. They would tell their patients to eat their vegetables. Our professions’ primary challenge is shifting from a very inconsistent message to one that is consistent.
Buying gold, guns, and canned food, as recently advocated by the author of Rich Dad, Poor Dad, is a message that should be addressed and corrected by financial planners. Those that follow advice like this will only win if a true economic catastrophe occurs. In any other scenario, they lose and squander their assets, probably in a big way. Those that bought gold, guns, and canned food are depending entirely on one commodity that over the past thirty years returned less than a savings account.
I don’t know if this is the response you wanted to provoke, but if we allow people to remain uninformed of the need for equities in their portfolio, then the profession will be in dire trouble. We get paid to provide professional guidance, not to tell people what they want to hear. Personally and professionally, I believe a CFP who does not include stocks in a clients plan, assuming age and risk tolerance indicate the need for equities, is breaching their fiduciary duty to do what is in their clients best interest.
Don Martin CFP says
Very good post. There is no guarantee that stocks in the future will return the 9% total return that they have provided in the past century. There have been cycles of roughly 30 years where the equity risk premium was negative, so if this occurred after a client had accumulated wealth then they would be worse off than the estimate from the plan produced by a typical financial planner.
So there is a real risk that unsophisticated financial planners could simply assume that futures returns will be at 9% and thus they would create a problem for the planning profession.
One possible solution is to run the financial planning software showing what would happen if someone incurred a very low rate of return for decades and then show alternatives such as investing in bonds during times when the cycle favors bonds, and then caution clients that they need to minimize debt and minimize consumption/use assets such as an owner occupied home.
Don St. Clair says
Good stuff Michael, and I for one very much appreciate the “rubbish” call. For years equities have been positioned by planners, the CFP Board, the mutual fund industry, most academic literature, NASD/FINRA and even the SEC as the “only way” to effectively combat the long-term effects of inflation (not/no longer true given advent of TIPS), but as you fairly point out – solving an income replacement problem involves living below one’s means, and saving the difference for use at a future date. There is more than the lever of investment returns available in the toolbox, and many of the other tools are arguable, more reliable than equities. I have to laugh every time I see another 401(k) study that “finds” the best way to double your retirement income is to double your retirement contribution… it took a formal study to tell us that?
To the broader question of whether the F/P profession has hitched it’s wagon to the future of the equities market, my answer is a resounding yes – absolutely we have. The irony to this is that in doing so, we have also hitched ourselves to wirehouse reps and other sellers of equities – while expecting consumers to distinguish the difference between an equities salesperson, and a “trusted adviser” who wants to help you purchase equities.
Joseph Alotta says
That’s why I advocate a global portfolio that pays dividends.
I am hearing a lot of talk about stocks being risky. So? Everything else you do in life is risky. Your health is risky. Your marriage is risky. Your commuting is risky.
I like John Lennon’s line: “Life is what happens while you were making other plans.”
Kay Conheady says
As financial planners who advise clients about how to build wealth to meet goals we, IMHO, simply must start to recognize that there are readily identifiable times when stocks are significantly more and less risky to invest in.
I will never again recommend stocks to clients when the P/E10 ratio moves beyond the mid-20’s. Business risk be darned!
Interestingly, if all investors (and advisers) were to adopt a valuation informed approach to investing that resulted in gradual lowering of stock market exposure as the P/E10 rose, we would rarely if ever again see catastrophic stock market losses that take a decade or more to recover from (like we’re dealing with today)!
I find the stock market future return prediction methodologies and track records of Butler/Philbrick and John Hussman to be quite compelling. Hussman, the currently more optimistic one, is predicting 3.5% annualized over the next 10 years – on a risk adjusted basis that end result would mean that bonds were (some would say predictably) the better place to have been for over 20 years (2000-2021)!!
Keep up the thought provoking work!
Roger Whitney says
I would argue that the entire financial services industry has tied their wagon to stocks via MPT. The “best practice” of the industry is based on a statistical theory designed to optimize risk/return trade off for an entity with no definite lifespan (with a limited investment universe). It is inevitable that some clients will live in seasons of subpar returns and suffer for it if they heeded our industry’s advice. Positioning clients to depend on investment performance to provide for their lifestyle is a recipe for disaster. Historically (beyond that mantra of the last 20 years) wealth was not created with public investment. It was created by work and savings. It is exactly our industry’s investment-centric approach that causes our industry not to help clients focus more on the levers in their lives that they have the most influence over: maximizing free-cash flow & savings,debt management, lifestyle management, tax planning, etc. Until we shed ourselves from the investment-centric approach and truly provide FINANCIAL COUNSEL rather than investment solutions it will difficult to be taken seriously as a profession.