Justin: In the last five years, we've had, you know, very low
volatility environment. You can almost be lulled into sleep about forgetting
about the potential downside of these portfolios.
So, so Steve, maybe to start us off, how do we think about kind of building
in, uh, some of these stress scenarios into the way we construct portfolios?
Steve: One thing maybe I'll address first is, is complacency, and this sort of
gets to some of the kind of behavioral issues.
You know, if you look at kind of what market volatility has been like for the
last five or so years, it's actually been relatively low, certainly low by, by
historical standards. And this is exactly the type of environment where
investors can get complacent. You know, "Why am I not keeping up with the
S&P 500?" You know, "Maybe I need to take more risk."
And this is why we utilize, actually, very long-term volatilities,
20-plus-year volatilities when we construct, uh, when we construct our model
If you think about the last 20 years, there's a lot of stress periods in
there. Obviously, everyone is familiar with 2008. There was a recession in
2001. There was the Asian financial crisis, the Russian financial crisis, the
dot com bubble. There's been a number of stress periods.
And so, when you, when you build portfolios based upon long-run volatilities,
typically you get more conservative portfolios, given the objective.
In terms of stress testing, this is another way to look at risk. You know,
sort of the traditional academic way is standard deviation. But, but there's
obviously other ways to look at risk too, and one of those is stress testing.
And stress testing entails decomposing the portfolio into its constituent risk
factors and seeing how those risk factors would have performed in historical
stress periods, say the 2008 financial crisis, maybe the taper tantrum when
interest rose—interest rates rose dramatically during the second half of
So, you want to look at risk, uh, in multiple ways, not just things like
standard deviation or volatility, which most people do, but also get some idea
about how the portfolio would be expected to perform under kind of different
historical stress periods.
Justin: Maybe, uh, maybe for Mary and Mark — You know,
and Mark, you mentioned it was a shock to clients — but what do you do
with that information once you have it and you see what the portfolio could do
in these different market environments?
Mark: Yeah. quite often it's a pretty eye-opening experience
for advisors when they see it. And really, then, how do you communicate that
appropriately to your client? So, with the home offices are trying to provide
both the tools and then the, the mechanisms to allow for that, to facilitate
that conversation. Is it an adjustment in the allocation? Is it thinking about
their withdrawal rates differently? Is it thinking about tax management or
planning a little bit differently?
So there's a lot of, uh, conversations that really jump off. As, as Mary sort
of mentioned, it really starts with that plan. And it's always, if your home
base is that financial plan, then you can adjust the portfolio, you can change
in and out of strategies, you can outsource to solution providers much easier
because, again, the objective is trying to meet the plan and the goals of the,
of the client's plan.e home offices have, have equipped their advisors with
some really good, uh, financial planning software that employs stochastic
And so, the conversation becomes, "What does this portfolio behave like
through sustained great markets or sustained bad markets or normal markets?"
And advisors, the good ones I work with, really hone in on those sustained
bear markets. And can we still meet the goal? What is the probability of
success if your portfolio had to endure these sustained down markets?
And so, if the answer is yes, great. But when those things happen, the, the
traditional emotions come through, but the advisor can go back and say,
"Remember, we had this conversation, and look, everything's still on course,
stay the course."
So the financial planning modeling is the science, but the art — and
this is where advisors do, in fact, earn their fees — the art is holding
the hands of the client even with the numbers in front of them that say,
"You're going to be okay." And advisors are getting much better at training
I just did a panel of advisors this week about that, and the market was very
volatile. The question from the audience was, "Your phone must be ringing off
the hook because of the crazy markets." And every advisor on the panel said,
"No, not at all. We've trained our clients to expect this. Their plans can
ride through it. And it's one day of volatility. And if that one day turns
into one week, we might get one or two phone calls."
So, it's been an interesting engagement to watch advisors really evolve their
way they do business with clients.
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