The Price Clients Pay for Worst-Case Forecasts

Bob Veres

Clients and the world at large give inordinate attention to downside scenarios, and nobody is calling our attention to the much larger upside of our business and investment landscape. The human brain amplifies this effect, because it is hardwired to notice threats much more than opportunities. I recently spoke with Dennis Stearns – an advisor who happens to be an expert in scenario planning – about the role planners need to play to counteract media-driven negativity.

The prevailing wisdom among many advisors – and a majority of their clients –is that the world is a dangerous place that is sliding downhill at an alarming rate. If we don't see disastrous consequences from the federal debt, the inflation rate arising from dramatic increases in the monetary supply will surely diminish our future lifestyles. European sovereign debt crises will eventually contaminate the American banking system, global warming will cause our coastal cities to flood, and there is no way in the world that wind farms will take up the slack when we finally run out of oil.

Taxes are still too high, the economy is a mess, Obamacare will wreck our nation's health and finances, America is analogous to the Roman Empire in its declining years, and Congress is too paralyzed to do anything except squabble and periodically raise its own salaries.

But what if things aren't as gloomy as they appear to be from the headlines and doomsday purveyors? Is it possible that the entire financial services profession is building conservative portfolios that hedge against these myriad risks, and as a result are exposing their clients to huge opportunity costs in a world that is, in reality, humming along just fine?

The most important skillset that a financial advisor can cultivate today is the ability to help clients see beyond the headlines, and have them ignore the persistent downbeat drums of the media.

This is the conclusion of Stearns, at Stearns Financial Services in Chapel Hill, N.C. Stearns’ expertise in scenario planning came from studying the process by which large companies construct and explore different possible futures so they can prepare for events that nobody expects. In his scenario-planning and forecasting work for his clients, Stearns has become convinced that our future can realistically be thought of as 25% risks and 75% opportunities. "The problem," he says, "is that the 25% threat is magnified by the 24/7 media to the point where everyone believes that it is actually the 75%." This may not be because reporters actually believe the world is going to hell in a handbasket, he adds, but because scary stories get eyeballs.

To take a recent example, consider all the economic-related coverage of the Japanese tsunami, especially the predictions that it would dramatically upset supply chains around the world and set the Japanese economy reeling. "If you look at the actual impact," says Stearns, "it was a little speed bump. All those wonks got on the media saying this will be something we won't recover from for decades."

Another example was the 2005 Asian bird flu scare, which two respected analysis, Don Coxe and Sherry Cooper, warned would trigger a 1930s-style collapse.