Talking clients down from the leverage ledge

Investors can be slow to pick up on market trends. And so it comes as no surprise that a few advisors I’ve spoken to recently have had to talk clients out of the idea of borrowing to invest.

While margin may have made sense for clients who could stomach risk in February or March when equities were at bargain levels, and loan rates on the floor, it’s far less practical today thanks to recent rallies.

What’s worse is that some of the clients raising the issue are the very ones who should be kept far away from such plays.

Scotia McLeod branch manager John Scott notes it’s inherently troubling when clients with low risk profiles start saying they don’t want GICs or other guaranteed products because rates are too low. When it happens, advisors need to stand their ground and explain the reasons why these clients are invested as they are.

“Using a margin account to load up on equities, thinking you’re going to make a lot of money can be a fascinating thing,” Scott says. “People can get drawn to a desire to recover their money quickly, and emotionally they search for a fast route.”

Scott warns advisors against letting clients get too deep into these notions. “The idea that, ‘I’m going to invest someone else’s money because I don’t have that money myself,’ is a risk in this market,” he says. “But I don’t see that as an appropriate route.”

Send ’em packing

Over the years, when clients have approached Calgary-based CFP Dirk Hohmann about leverage, he has told them to work with another advisor.

“Early on in my career I decided that I like to sleep at night,” he says. “There are some people for whom it might be the right fit, but I don’t feel comfortable.”

While he’s seen other advisors make the numbers for leveraging strategies look good on paper, Hohmann questions how often everything in a person’s life goes exactly as planned.

He speculates a lot of advisors who recommend borrowing to invest do so out of a desire to build asset bases faster. There’s pressure from within the industry to accumulate quickly, and a need among younger advisors to obtain a livable income off the trailers.

“A lot of new guys have to eat, so they think it makes sense,” Hohmann says. “But it’s not for me. The client needs to be put first.

“I’m very inefficient at building my asset base because I’ve always done it a hundred bucks at a time,” he adds. “I could have done it faster but I didn’t want to have to cross the street when I see a client coming.”

Scott adds, “We don’t tend to have a lot of margin activity, but I can see how people would use interest rates being so low to do something. What the advisor has to ask is, ‘Does it make sense?'”

For clients without play money, it generally doesn’t.

Dealing with debt

Scott describes one encounter with a couple in which the husband was interested in margin but the wife was wary.

The couple had just paid off their house and it almost seemed as if there was a desire on the husband’s part to keep making payments to the bank because he’d been doing it for so long.

In other words, debt had become a habit.

“Instead,” Scott says, “a huge focus should be to getting debt free and staying that way, rather than getting back into more debt.”

Hohmann agrees, especially since the generation that survived the Depression is debt averse by nature. That mentality is another reason he’s wary of margin strategies.

“Most of those people who have worked hard to pay off their debts don’t want to go back there,” he says. “I didn’t want to have to go back to someone in their 50s and 60s and tell them, ‘You owe money again.'”

Retirement realities

Part of the motivation for margin, Hohmann says, may stem from the way advisors pitch retirement needs to clients.

“Too many advisors try to scare clients into believing if they don’t have a certain amount of money, they’ll be destitute,” he says. “But the reality is you’re not going to buy a motor home if you’ve never been camping.”

Scott adds that pressure may also stem from the perceived need to quickly recover losses from the last market drop. “They think they can make 20%, give back 2% and give the balance back to their retirement plans,” he says.

Hohmann says it’s up to advisors to not oversell and better manage client expectations.

“It’s not rocket science,” he says. “If you like fishing now, you’ll probably still like it when you retire.”

(08/20/09)