By far, the hardest part of managing other people’s money is not just the research that goes into building a portfolio or picking the specific assets, but the psychology of how a client feels relative to the current marketplace and their specific goals, which are not always realistic. Of course, as a fiduciary, there is a lot of information needed from a client before recommending portfolio allocations and assets. We all wish we could easily fulfill most clients’ request to “just make money, but don’t lose a dime.” Unfortunately, as professionals, we realize that has never been possible, nor will it ever be. However, what I have learned is that the more education you provide a client about the complexity and nuances of investing, the better they become not only as investors but as clients.
Therefore, below are some thoughts you might want to implement with new clients or review with current ones.
1. Investment objectives—What are the client’s overall investment goals, dreams, abilities and portfolio structure—assuming they have one? Obviously it’s important to know if clients are high-net-worth clients, what kind of liquid net worth they have, what their income levels are, investing time horizon, retirement income needs, overall strategy, and even preconceived return assumptions. Without discussing this kind of in-depth information with a client, matching their goals and objectives to the portfolio construction can easily become misguided.
2. Investing principles—these are fundamental or general truth or law; sometimes they are an underlying theory or belief. What does the client believe are the best investment vehicles? Mutual funds, exchange-traded funds, individual stocks/bonds, or the newest, often fictitious guaranteed products that are one-size-fits-all? This discussion provides a great opportunity to understand a client’s preconceived ideas, as well as the opportunity for you to educate them on what vehicles are best for them, based on the big picture and their specific financial goals.
3. Investing strategies—What does the client understand about investment strategy and what is their plan of attack to guide their investment decisions? What are their thoughts about market timing, buy and hold, asset allocation, passive or active investing, socially responsible investing, tax-free vs. taxable structures, or does the client have 100% confidence in a specific industry/sector? While most investors don’t fully understand the complexities of using different strategies, hopefully such a discussion will increase their appreciation for the advice you provide.
4. Risk tolerance is the degree of uncertainty an investor can handle relative to the negative change in value of the assets in question. This is where the rubber meets the road. Get this wrong within the client’s portfolio structure and you could easily lose the client during market turmoil. The tough question is “how does a client feel today if the value of their investments drops 5, 10, 15, 20 or even 30% at some time in a future recession or bear market?”
5. Diversification within the portfolio protects against extreme risk of loss and volatility. The risk of losing some or all of a client’s money is highly avoidable if properly diversified (assuming markets always prevail). Certainly, doubling or tripling the value of a client’s portfolio from a one-time lottery stock pick is probably not going to happen, but losing all they have due to large stakes in an Enron or Lehman Brothers won’t happen either if properly diversified. I’ve learned that the term means different things to different people, so clients need to understand the context of diversification: how it looks, feels and works. In the words of famed mutual fund pioneer John Templeton, “The only investors who shouldn’t diversify are those who are right 100 percent of the time.”
6. Returns—defined as the result of an investor’s portfolio objectives, principles, strategy, risk tolerance and diversification, while targeting an expected future outcome which may or may not happen, depending largely on the marketplace. Clients must understand all aspects of what total returns are: dividends, interest, capital appreciation, long- and short-term capital gains, capital distributions, etc. They need to know that generating returns isn’t simple or quick, but a highly complex combination of all aspects mentioned above that happens over time. Exclude one aspect and you’re guaranteed to lag behind those advisors who invest for total return and for the long-term. As Phillip Fisher once said, “The stock market is filled with individuals who know the price of everything, but the value of nothing.”
These are definitely not all the possible elements of building a portfolio, but they are very important for being successful in managing money and retaining clients. We should all continuously question our investment strategies and allocations even if our answers don’t change, because it will keep us on our toes and better positioned to provide the best advice to clients. The better you’re able to answer your client’s questions regarding the age-old question of “Why,” the more likely they are to respect and trust your advice.