The 3-dimensional planner
The financial planner’s role extends beyond investments to advisement on market volatility
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