Fearful clients? Teach them to embrace risk

In 2022, the world is awash in anxiety — and we can't put all the blame on the evil Japanese fox spirit that recently escaped its prison. 

According to the World Health Organization, cases of anxiety increased by a whopping 25% in 2020 when the COVID-19 pandemic began. Since then, we've been dealing with political and social unrest, a trade war with China, a looming retirement crisis, and now war in Europe and monkeypox. In such an environment, clients are prone to make impulsive, fear-based decisions, and when such decisions impact retirement savings, long-term consequences can ensue.

We like to think we make rational decisions based on the information available. But in truth, our brains use cognitive biases — psychologists call them "heuristics"— to make decisions more efficiently. And while we try to consider all the information available to us, we tend to employ the information we can easily recall. This can lead to fear-based decision-making — which is not a bad thing when it's "optimally matched to a given threat," according to psychologist Joe Pierre — and can even be lifesaving when one is, say, held at gunpoint or finds a rattlesnake at one's feet. But, Pierre says, fear works against us when it's disproportionate to the threat, which can happen when the actual risks are unknown.

The role of a financial advisor has changed considerably over the last several years. Where it once might have been enough to manage a client's portfolio, maximizing gains and minimizing losses, that's now the baseline. In today's climate, advisors need to adopt a more holistic approach with their clients. Cultivating a sense of curiosity about a client's retirement goals is an effective way to build trust and, perhaps even more importantly, can result in learning more about what motivates a client's decisions, helping you to help them avoid nasty financial pitfalls.

Wrapping risk
It's natural that clients should feel risk-averse right now, but risk avoidance itself can be risky if it stunts a portfolio's growth in the run-up to retirement. When clients call in a panic, it's the advisor's responsibility to get them to take a deep breath and help them figure out what they're actually afraid of. A client's sudden desire to move their investments to cash, for instance, could be motivated by the wish for control in the face of geopolitical destabilization and other uncontrollable uncertainties. That's when selling low can occur — sometimes to harmful effect. 

Defensively, what we're talking about here is protecting clients from themselves. But what if we encourage them to transfer some risk to an insurance company so that they might take on more equity risk and protect their spending power in retirement? Such protection works in all markets.

In a white paper, Michael Finke, Investments/Retirement professor, and Frank M. Engle, Chair of Economic Security at The American College, discusses an innovative, advisory annuity product that he likens to "portfolio income insurance." Contingent deferred annuities, sometimes referred to as a Stand-Alone Living Benefit, offer insurance protections on a clients' brokerage accounts, IRAs or Roth IRAs that "preserves the possible gain from taking risk while eliminating the downside consequence of low returns on spending." 

Finke notes that many many investors are uncomfortable with factors outside their control dictating the amount they can safely spend each year in retirement. They value the certainty that lifetime income delivers in the event that their No. 1 fear is realized: Outlasting their retirement savings.

Embracing Risk
When economic uncertainty runs rampant, it's important to remind clients that risk is a tool and, just like any tool, is treacherous when employed without considering your clients' risk profile. But in skilled hands, it can be powerful. You, the trusted advisor, are those skilled hands, and helping clients take on and wrap some risk, rather than avoiding it entirely, makes sense. Because at the end of the day, a life devoid of risk isn't possible and embracing it can offer rewards.

Just steer clear of thousand-year old fox demons along the way.