Financial services providers and advisors frequently focus on beating their benchmarks, but investors prefer an emphasis on downside protection by a three-to-one margin, according to a new report from a global research and consulting firm Cerulli Associates.
The report — Cerulli’s third-quarter issue of The Cerulli Edge – U.S. Retail Investor Edition — compares the responses of protection-focused investors with their performance-seeking peers to help better understand the dynamics facing participants in the retail investor market.
“Our most recent research suggests that providers must take a proactive stance to help investors become comfortable with the realities of equity market exposure,” Scott Smith, director of advice relationships at Cerulli Associates, said in a statement. “Balancing downside protection with the growth potential necessary to help investors reach their wealth accumulation goals is one of the most challenging scenarios facing financial services providers.”
According to the report, more than three-quarters of investors explicitly state that they would prefer a protection-focused portfolio versus one that outperforms.
The report then examines which investors are more protection-focused based on age and wealth.
When viewed on a wealth tier basis, the highest concentrations of this protection-focused opinion are among those investors with $250,000 to $500,000 (83%) and greater than $5 million (80%).
According to the report, this opinion might make sense for those in the higher wealth tiers, as their current asset levels are generally sufficient to meet retirement income needs.
However, those in the $250,000 to $500,000 level underscore the challenge that advisors may face.
“These investors have made headway in accumulating a considerable portfolio, but are reluctant to take on the market risk that is likely necessary to attain their accumulation objectives,” the report states.
Meanwhile, looking by age, the report finds that a protection mindset is highly concentrated among investors who are 60 and older and among affluent investors under 30 years old.
“With a relatively short investment horizon, those age 60 and older have adopted an appropriate approach to their wealth, while those under age 30 have an extended window to overcome any downmarket periods, but are reluctant to take on volatility,” the report states.
As the report notes, these results underscore the importance of advisory relationships for investors. If investors were left to their own devices, they would tend to “skew away” from creating portfolios that would provide them with the greatest likelihoods of achieving their accumulation goals, according to the report.
“While there are myriad avenues to educate themselves on the basics of portfolio construction, most investors lack the willingness, confidence or time to take this on themselves,” Smith said in a statement. “This is simply not an area that most investors are eager to spend substantial time and effort learning.”
The gap between investors’ preferences and accepted best practices in long-term portfolio construction leaves advisors facing a real threat of disenchanted customers when markets struggle.
“To help bridge this gap, [advisors] must make every effort to help investors view their appetite for risk in terms of their risk capacity, rather than independently,” Smith said in a statement.
The report suggests having recurring discussions after establishing a baseline agreement on appropriate portfolio risk. According to the report, these discussions must be a recurring part of an advisory relationship to reinforce the likelihood of down markets and to help view them as opportunistic discounts rather than tragedies.