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Have no doubt that the stock market is a difficult beast for even the most prudent of beast-masters to tame. Now that you’re thinking about being a financial advisor where you manage money on the behalf of others, such a truth becomes even more apparent. In this article, we are going to discuss five things that every financial advisor should know about the stock market. Hopefully, this will serve to make you better prepared to be a great advisor.
1. Market Timing Isn’t for Financial Advisors
When I was a little kid, I used to get so excited about my dream of becoming a financial advisor. Why, you ask? Because I knew I was going to be able to play the market with millions of dollars that other people owned.
HALT! Playing the market, or “timing the market” as it is more colloquially known–buying low and selling high–is forbidden to all but the best of active money managers. Not only will you drive up the fees of your clients doing this…you are also very likely to lose their principal.
2. Mutual Funds: Step Aside
In the past, a good FA would take client money and invest it in the best mutual funds. These funds would produce reasonable returns, offer great diversification, and weren’t too expensive (around 1-2%/year at the time).
Now, the emergence of Exchange Traded Funds (ETFs) have served to make most mutual funds outdated. Not only do ETFs charge lower expense ratios on average, they also result in less portfolio turnover each year, which effectively lowers your clients’ taxes. So, if you are going to invest in a mutual fund for your clients…really consider the costs first.
3. Right Now, The Market is Historically Overvalued
Using the Cape Shiller Ratio, which tracks inflation-adjusted earnings per share over the past ten years and compares them to price paid for stocks on the S&P 500, the market currently sits at lofty valuations only seen twice before: during the Tech Bubble of the 2000s and right before the beginning of the Great Depression.
This doesn’t mean that there aren’t good investments out there on the markets right now, but it does mean that you will need to tread carefully and really do good firm research before investing client monies.
The Value of a Stock is Based on Its Expected Future Earnings
A company is only worth as much as what it is able to pay to its owners. Shareholders base the price of stocks on what they believe that a company will be able to pay out in dividends per share in the near-to-medium term future.
The two most popular models for calculating share value used today are the Dividend Discount Model and the Discounted Cash Flow Model. You can learn more about both of these formulas and how to calculate them on a daily basis on Investopedia.
Rule #1: Never Lose Principal
Warren Buffett’s most famous rule of investing is to “never lose your principal”. If you are concerned about how to manage clients’ money during tumultuous market periods (i.e. today), that doesn’t mean that you should quit.
Rather, always seek to be learning. Learn how to produce better returns for your clients while keeping their money equally as safe. Read great books and expand your mind on finance subjects, refusing to ever shut down your brain simply because that is simpler. I recommend:
- The Intelligent Investor–Benjamin Graham
- Ahead of the Market–Mitch Zacks
Conclusion: Doing Right By Your Clients
Truly, the job of a financial advisor can be one of the most stressful jobs on the planet, especially during market downturn periods. However, if you heed the advice listed above regarding the five things that every financial advisor should know, deal with the market as rationally as possible, and always put your client’s interests first, you will undoubtedly succeed!
Related Resource: Top 10 Best Online Master’s in Finance Degree Programs
