When an image is formed on our retinas, it starts out upside down. The optic part of the brain puts in some hard work to flip that image so it makes sense to the way our brain wants the world to look.
Too often when talking about performance, clients receive their information upside down, and it never gets flipped so they can see it correctly. Their advisors don’t put in the work to help them see their information right side up.
Talking about performance, and setting expectations about a portfolio’s returns, are fundamental elements of being an advisor. With the wealth of knowledge and technology available to us today, there are some concrete steps that advisors can take to make the process of understanding easier.
The Theory of Simplicity
As we delve into the idea of talking about performance with clients in a way that makes sense to the average investor, I want to start with modern portfolio theory. Modern portfolio theory attempts to maximize returns in exchange for a given amount of risk, or on the flip side, minimize risk for a given expected level of returns. The way risk and return are managed is through a careful selection and allocation of assets.
It’s likely you’re at least somewhat familiar with this idea, even if you don’t actively recognize modern portfolio theory as the driving force behind the investment decisions you help your clients to make. The importance of diversification and asset allocation are critical in managing risk and helping to set client expectations for the rates of return they may be able to expect.
Now, all that said, modern portfolio theory can be complex. You can’t begin a meeting with a client talking about asset diversification without first explaining some of the terminology you’ll be using, but modern portfolio theory can set the framework you draw from when discussing risk and returns with your clients. If you need some assistance, there is technology available to help guide those conversations.
Connecting the Dots