The 3-di­men­sional planner

The fi­nan­cial planner’s role ex­tends be­yond in­vest­ments to ad­vise­ment on mar­ket volatil­ity

Accounting Today - - Financialplanning - By John P. Napolitano See PLANNER on 29

Reg­u­lar read­ers will know that I am an ar­dent ad­vo­cate for proac­tive and holis­tic fi­nan­cial plan­ning. Un­for­tu­nately, too many ad­vi­sors give lip ser­vice to this ser­vice level and morph into what clients are used to: some­one who over­sees their in­vest­ments. For those in that camp, clients typ­i­cally ring your phone each time there is a bad day or week in the mar­kets, or when some news­wor­thy event has them afraid that their port­fo­lio is doomed.

The fi­nan­cial plan­ning process is com­plex and in­cludes many ar­eas. Specif­i­cally, the text­books de­scribe the role of a fi­nan­cial planner to ad­vise on mat­ters of cash flow to­day and in the fu­ture, risk man­age­ment, re­tire­ment plan­ning, in­come tax plan­ning, in­vest­ment plan­ning, es­tate plan­ning, busi­ness suc­ces­sion, fam­ily gov­er­nance and just about any fi­nan­cial is­sue that comes up in the lives of your clients. No­tice that in­vest­ment plan­ning is just one of the crit­i­cal com­po­nents of a fi­nan­cial plan­ning re­la­tion­ship, al­beit a very im­por­tant one.

The mar­ket­place of fi­nan­cial ad­vi­sors (note that I didn’t use the term fi­nan­cial planner) over the years has shaped the con­sumers’ view of what con­sti­tutes a good re­la­tion­ship with them. In short, most peo­ple think that fi­nan­cial plan­ning is all about in­vest­ing. The fi­nan­cial com­mu­nity, of course, is OK with that, as most rev­enues are gen­er­ated from as­set man­age­ment or over­sight. Ig­nor­ing the re­main­ing items that would rea­son­ably be in­cluded in a fi­nan­cial plan­ning en­gage­ment saves the ad­vi­sor a lot of time — ex­cept dur­ing times of high mar­ket volatil­ity.

The sin­gle-di­men­sional re­la­tion­ship un­der­pinned by in­vest­ments puts the spot­light on you dur­ing times of mar­ket volatil­ity. Es­pe­cially if you try to sound like some big shot an­a­lyst who be­lieves their own fore­casts. The re­al­ity, how­ever, is that nei­ther you nor any­one else that calls them­selves an in­vest­ment pro­fes­sional knows the date when mar­kets will dip and the date when mar­kets will start to rise again. Some tac­ti­cal man­agers will claim to have that abil­ity, but in my ex­pe­ri­ence, most tac­ti­cal man­agers use al­go­rith­mic for­mu­las that work un­til they don’t. Most that we’ve re­searched have had ex­tra­or­di­nary pe­ri­ods where their se­cret sauce worked great, along with times when their magic se­cret sauce didn’t work at all. Mar­kets go up and down, as do most port­fo­lios.

I be­lieve that the planner’s role with re­spect to mar­ket volatil­ity is to have open dis­cus­sions about volatil­ity when you en­gage with a client. If your client has a high risk tol­er­ance, and wants their in­vest­ments to match the per­for­mance that they hear about in the news, then you bet­ter ex­plain mar­kets and volatil­ity to them. It’s rare to have a year like 2017 where volatil­ity was hardly no­tice­able.

I like to see volatil­ity ex­plained in terms of the range of ex­pec­ta­tions for any in­vest­ment. Of course, the com­pli­ance peo­ple would be very un­happy with me if I didn’t re­mind you that past per­for­mance is no guar­an­tee of fu­ture re­sults — but you al­ready knew that. But an ed­u­ca­tion for clients about the past range of per­for­mance for the mar­kets or the spe­cific port­fo­lio that you may rec­om­mend can be help­ful to all. Show­ing a client how well and how badly a par­ticu- lar in­vest­ment has fared in the past is worth not­ing.

Two port­fo­lio ap­proaches

There are two ways to find out what is the op­ti­mum port­fo­lio for your client. One is to math­e­mat­i­cally cal­cu­late what they need to earn in or­der to meet their life’s ob­jec­tives. The other is to dis­cover their tol­er­ance for risk, and learn just how much volatil­ity they can take.

The math­e­mat­i­cal take sounds very in­tu­itive and log­i­cal un­til you get into the de­tails. In or­der to cal­cu­late the rate of re­turn re­quired by your client, a for­mula that in­cludes many vari­ables must be de­ployed. Many of these vari­ables are out of your con­trol.

The cal­cu­la­tion starts with a spend­ing need or de­sire, which can be quan­ti­fied with lit­tle ef­fort. But be­yond that, you will use vari­ables that are out of our con­trol. In­fla­tion, tax rate, and port­fo­lio re­sults are just a few.

While to­day you may all agree on the rea­son­able­ness of the as­sump­tions used, we all know that they will not be 100 per­cent ac­cu­rate and that the fore­casts will need to be re­assessed for the shifts that will oc­cur within the vari­ables. A good fi­nan­cial planner will rec­on­cile each year the fore­casts they de­liv­ered in the prior year to the re­al­i­ties of the cur­rent day, and then ad­just the plan ac­cord­ingly if nec­es­sary.

The sec­ond method is to use a risk tol­er­ance ques­tion­naire. This may feel a lit­tle su­per­fi­cial, but as each day passes there are tech­nol­ogy tools be­ing in­tro­duced that try to make this es­ti­mate of just how much risk your clients can tol­er­ate into a quan­tifi­able an­swer. Noth­ing in the RTQ space is fool­proof, so find one that works for your firm and use it with ev­ery client.

With a lit­tle luck, you’ll find that your client’s quan­ti­ta­tive take off is not too far to the left or right of the risk as­sess­ment tool that you are us­ing. If there is dis­cord, it can’t be ig­nored. If your client needs to earn a rel­a­tively high amount but has ab­so­lutely no tol­er­ance for risk, you must speak up.

It’s the planner’s job to come up with al­ter­na­tive so­lu­tions, as painful as they

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