Much has been said about the science and the art of investing. There should be: it’s a complex business. In the end, though, both the science and art really serve a single objective: maximizing returns within the constraints of a client’s specific investment goals and risk tolerance.
For advisors these days, who must contend with a market that’s suddenly volatile again as well as a staggering array of investment products, that’s a pretty tall order. It can be done, though, and I humbly suggest that the best – maybe the only – way to achieve success as I’ve defined it is to look at a client’s entire portfolio from a holistic perspective.
And just what does that mean? Well, since most investors use a combination of tax-deferred and taxable investment accounts to save for their retirement, it means that advisors have to take more of a household approach to reviewing a client’s entire portfolio. What’s more, it means that an advisor must talk to clients about the assets he or she doesn’t manage as well as the assets he or she does. It’s not unreasonable to suggest that the best way for a financial advisor (FA) to be really effective for a client is to fully understand the client’s total asset-allocation profile.
It’s More Than Personal…
Running an asset allocation model on a personal account—or the FA’s portion of the personal portfolio—is simply not enough. A holistic approach will require running at least two separate models: one on the taxable investments, utilizing after-tax return assumptions, and another on the tax-deferred accounts, using pre-tax return assumptions.
In practice, the allocation process will more often than not deploy high-growth, yield and turnover assets–actively managed equities, for example–in the retirement accounts and more tax-efficient assets–municipal bonds, passive index funds and the like–in the personal accounts. It’s easy enough from there to roll up all the models into a household-level asset allocation report to get an accurate view of the aggregate portfolio.
The good news, however, is since you understand the components of return and the correlations between pairs of asset classes so well, you’ll have a good opportunity to allocate assets more efficiently between your clients’ personal and retirement accounts. The bad news?
There’s no magic formula for determining the ideal model with any kind of precision. At the risk of sounding too much like an economist, I have to say that the most appropriate solution will depend on the situation.