Will a Recession Occur? The Best Response to That Question

Investors love to spend an insane amount of time and energy on things that are unpredictable and uncontrollable. This desire – to predict the unpredictable and control the uncontrollable – is actually a rational response. Uncertainty is very painful to our brain – which is a planning machine. Oftentimes “not knowing” is worse than getting bad news. Because when you get the bad news, we can plan and move forward. The brain will do anything to know the future, and may not distinguish between an illusion and reality.

The Absurdity of Recession Talk

I don’t know if it is necessary to share all the evidence that shows that experts (and advisors) are horrible at predicting recessions. We predict those that never occur, which happened several times in the past few years. And sometimes we don’t even predict the recession when we are actually in it. According to Nate Silver, economists failed to predict recessions while we were experiencing them in 1990, 2001, and 2007. In addition, economists gave only a 3% chance for a recession in 2008 (we had a brutal one).

Advisors aren’t that much better predicting (or responding to) recessions. In the Great Recession of 2007/2008, a study of over 4,000 RIA’s and CFP’s found that investor accounts managed by them doubled their conservative holdings from the start of the Great Recession in late 2007 to the bottom in March of 2009. The average cash and bond allocation went from 26% before it all started to 51% at the very bottom of the market.

Of course advisors blame the clients for that move. But then those advisors aren’t real advisors, they are order takers. A real advisor proactively and consistently coaches their clients.

Why We Talk About It

It’s hard not to answer a question that someone poses to us. We want to demonstrate our analytical ability and sounding smart feeds our ego (subconsciously). Even this very day, there are likely thousands of advisors providing inquisitive clients their best guesstimates – talking about inflation, the Fed, employment, and maybe even the political landscape. Basically advisors are talking about things that are both unpredictable and uncontrollable. They are feeding their clients’ misaligned focus. No wonder advisors raised cash for their clients as their values went down. Rather than coaching them, advisors are providing them with garbage. But it sure does sound good at the time!

The Best (and only) Response

So what is an advisor to do when a client asks whether we will go into a recession? Here is there answer. Tell them it doesn’t matter. The best advisors are those that can lovingly and directly tell their clients the real truth. Rather than speculate about what may or may not happen, investors need to know that the answer to their question doesn’t matter.

It doesn’t matter because no one can predict recessions. It doesn’t matter because we often predict recessions that don’t occur. It doesn’t matter because we can’t even identify when we are in the middle of a recession. And finally, and this is the big one, it doesn’t matter because the market doesn’t care if we are technically in a recession or not.

Since the market is a discounting mechanism, it is quite possible that by the time we are in an official recession, the market may have already bottomed. The real concern of clients is not whether we will go into a recession. It is how far their account values will go down, and for how long, regardless of we are in a recession or just anticipating one that never occurs.

The real discussion ought to be about what the client will do if their portfolio drops 20% from current levels, regardless of what causes it. Then we can have a discussion and draft a plan. And the good news is, we just moved the discussion from something completely out of their control, to something in their control. That’s empowering and effective coaching!

– JAY

 

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