As Bubble Fears Percolate, Advisors Are Bracing for a Crunch

For as long as there have been financial markets, there have been warnings of market bubbles and looming corrections. While this time is no different, it still poses a thorny dilemma for financial advisors charged with helping clients navigate whatever the next market cycle brings without doing too much damage to their savings and investments.

Four years in, a bull market for US equities that followed the 2022 correction has started to attract some gloomy forecasts, largely because it’s underpinned by an artificial intelligence wave that could easily be described as overvalued under multiple measures.

Recent remarks by billionaire Bridgewater Associates founder Ray Dalio warn of a potential liquidity crisis for investors and underscore the distinction between net worth and the kind of actual cash that could be needed in a market pullback.

“Wealth is not the same as money,” Dalio said on a recent podcast. “You see a lot of people getting wealthy but you can’t spend the wealth.”

Honey, I Crunched the Cash

For seasoned financial advisors, this might not seem like a novel perspective, but it stands out as a fresh reminder that, whether markets are frothy or not, preparing for the worst never hurts. “The market returns have been fantastic, and it is unlikely to continue at the current pace over the next few years; however, it’s impossible to predict when or why the next downturn will come,” said Jon Lapp, founder of Haven Financial Advisors.

With that in mind, Lapp said he only adjusts client portfolios and investment strategies when something changes related to risk tolerance or investment goals. “If those things haven’t changed, we strongly discourage making changes with the intent of timing the next market downturn,” he said. “I have had clients insist on doing this in the past, against my recommendation, and none of them have come out better in the long run.”

Beyond the knee-jerk reaction of trying to time major market movements, some financial advisors are double-checking client portfolios to ensure proper liquidity in the event a market correction puts some dents in holdings. Managing liquidity is the delicate balance of keeping enough cash available that clients are not selling low, either to meet basic expenditures or to fund major planned events like weddings, vacations or real estate acquisitions.

“Liquidity is often more valuable than investors realize because its importance tends to become apparent during a major downturn, when access to cash may become more difficult,” said Alex Shahidi, senior managing director at Evoke Advisors. “We help clients separate long-term assets from near-term spending needs by maintaining adequate liquidity and stress-testing portfolios against adverse scenarios,” he added. “The goal is to ensure that a temporary decline in asset values doesn’t force permanent losses through ill-timed asset sales.”

Keep Cash, Beat the Crash

Tracy Gallagher, head of investment strategy at Allocate, said liquidity management is not something you wait to address. “The best time to have this talk is when no one is asking for it,” she said. “Deal with it in a rally, when forms of liquidity and diversification are a lot easier to achieve in a portfolio.” Gallagher said she matches cash and short-duration assets to known spending needs so that a market decline doesn’t create a forced sale or withdrawal.

A key part of the strategy, she added, is ensuring clients understand the importance of liquidity inside an overall portfolio. “There is a lot of liquid-ish or liquid-with-a-price-tag net worth, such as concentrated single-stock positions that can be hard to unwind, and vested but illiquid equity compensation can lead to similar problems,” Gallagher said. “Mapping liquid holdings next to true cash and cash equivalents can help clients grasp the true liquidity in their portfolio.”

For the most part, liquidity management is a bigger concern for investors in or near retirement when the income is generally fixed and there is a dependence on a retirement portfolio.

Cash Me If You Can

For those clients still in the accumulation phase, market pullbacks can be blessings in disguise, according to Edward Mahaffy, president of ClientFirst Wealth, Legacy & Estate Planning.

“If you are early in the wealth accumulation phase, you are able to continue accumulating shares at cheaper levels when a selloff occurs,” he said. “As always, the devil is in the details. If you own index funds, you should be aware of the weighting to more volatile sectors, such as tech, for instance, which has a large weighting in the S&P 500.”

Ryan Marshall, a partner at ELA Financial Group, believes advisors and market watchers should use caution when calling stock market tops or describing them as bubbles. But he is cognizant of looming risks building across the artificial intelligence categories. “You will never consistently pick the perfect time to buy or sell,” he said. “At this point, we are focused on managing concentration risk, maintaining appropriate liquidity and keeping portfolios aligned with each client’s long-term plan.”

Musical Chairs. Meanwhile, Jess Skolnick, owner of Mindi Financial, believes the bubble threat is real and quite evident. “We are in a bubble right now,” she said. “It all boils down to whether the tremendous amount of capital investment in the AI buildout will result in revenue to justify the expense, and I don’t see any evidence that it will.” Skolnick acknowledges she could have easily made the same argument a year ago, but the difference now is “more and more of this AI spend is coming from debt rather than cash.”

“No one knows when the music will stop, even if you know it can’t continue forever,” she added. “That said, I have made some adjustments to my clients’ portfolios that will keep them invested but will hopefully mitigate some of the risk if the bubble bursts.”

Shahidi of Evoke sees market forecasts, particularly ominous ones, as reminders of the importance of being prepared.

“A common mistake is treating liquidity as an afterthought during strong markets,” he said. “Liquidity can be an underappreciated asset in investing, and its value often isn’t recognized until a surprise downturn reveals the difference between having wealth on paper and having flexibility in practice.”