Visualizing the benefits of risk management
Visualizing the benefits of risk management
Behavioral research often talks about the power of “visualization.” For advisors, it is a way of reinforcing for clients the importance of risk management in adhering to their financial and investment plans.
In February, senior market strategist and wealth advisor Steve Deppe wrote about an analogy between the strategy in a Kansas City Chiefs 2021 NFL playoff game and investor behavior.
In that example, the point was how financial advisors could help their clients with the concept of “behavioral adherence,” or sticking with a well-constructed and risk-managed investment plan even when times get tough.
Mr. Deppe concluded, “Clients are far more willing to stick with an investment plan if a significant percentage of their portfolio incorporates active, or tactical, risk-managed strategies.”
Another recent event prompted some further thoughts about analogies to principles of investment management.
After its landing on Mars, NASA’s Perseverance rover kept much of the nation transfixed with the remarkable images it sent back to Earth.
After the culmination of the spacecraft’s seven-month trip through space, acting NASA Administrator Steve Jurczyk said,
Risk management is paramount for any space exploration mission and is implemented in many ways through exhaustive preparation and testing and numerous system redundancies.
A scientific article noted,
In our advisor interviews for Proactive Advisor Magazine, I often ask the question, “Do you ever use analogies with clients in explaining your firm’s approach to investment management, and, specifically, to risk management?”
I have never been told about an analogy to space exploration, but several advisors we have interviewed are former Air Force officers or airline pilots.
One told us,
Behavioral psychology research often talks about the power of “visualization.” In the case of behavioral finance, this can often refer to visualizing future outcomes, like the eventual purchase of that perfect retirement home in the ideal location. It is a way of reinforcing the importance of discipline in adhering to a financial and investment plan, with definite goals outlined for the future.
“Visualization” is also a well-known teaching technique, one often used by financial advisors.
A 2018 article in Investor’s Business Daily noted,
One of the analogies I often hear related to investment risk management is about as simple as it gets.
Several advisors have told me that they will ask clients the question, “If you were standing on a railroad track and a train was bearing down on you, wouldn’t it make sense to get off the tracks?”
When they get the inevitable head nod “yes,” they go on to relate this concept to the practical wisdom of employing risk-managed investment strategies that can reduce market exposure partially or completely when market trends and indicators are pointing toward a potentially significant market downturn.
An advisor in the upper Midwest uses weather extremes to provide an excellent analogy to tactical money management. He told us,
I have heard many different types of analogies from advisors describing active risk management, with common themes revolving around sports, stormy weather, safeguards in building construction, farming, going on a trip, driving a car, or piloting a boat. They all have merit.
One phrase I particularly like is, “Having a risk-managed portfolio is like bowling with the bumper or guard rails raised on the lane.”
It also is gratifying to see risk-management concepts come to life, in real time.
Last year presented such an opportunity for financial advisors and investors.
2020 started at the tail-end of the longest bull market in history. In March, the coronavirus pandemic swiftly and unexpectedly plunged major equity indexes into a bear market.
Then, almost as quickly, the markets recovered, ending the year in a new bull market and making new all-time highs.
In speaking with several advisors about their experience navigating 2020 for client portfolios, those using the services of third-party managers who employ an active, “risk first” investment philosophy said they were quite pleased with the results.
An advisor from the Southwest told us,
However, financial advisors and their clients do not only want to mitigate drawdowns for their investment portfolios. They also want to employ risk-managed strategies that can take advantage of upside opportunity when financial markets rebound off lows.
One advisor on the East Coast reviewed his overall investment performance on behalf of clients for the entirety of 2020 (with the caveat that performance would vary by each client’s investment plan, risk profile, and time horizon.)
While it would be a pretty big stretch to compare a quantitative approach to investment management to a NASA scientific mission, they both do share a belief in the concepts of exhaustive data analysis, sophisticated algorithms and models, computing power appropriate to the task at hand, and “redundant systems” for managing risk.
According to NASA, the Perseverance rover mission is just one step in the Mars Exploration Program, “a long-term effort of robotic exploration.” Congratulations to all those involved for a job well done!
The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.
Image by NASA/JPL-Caltech