How To Define An Adviser’s Work

December 16, 2015

[This article was first published in the December 2015 issue of ETF Report UK]


It's not about beating the market, it's about achieving the client's long term needs

If I asked my grandson, "What's the definition of 'long term'?" he may answer that it's the time he spends doing homework. If I asked a university student the same question, it may be the time it takes to establish a career. A middle aged person may define it as retirement. A retired person may think for a second and answer, "It's a lot shorter than it used to be."

We investment professionals like to tell people to invest "for the long term." That sounds like an eternity. What does this mean? Is it next week, next month, next year or decades from now? Tongue in cheek, I think some investors believe the definition of a long term investment is a short term investment that didn't work out.

Jokes aside, an important question is: How can we advise our clients on what's best for their long term needs when we can't agree on what "long term" means?

Asking Clients The Right Questions

Perhaps it's better to define this elusive time frame by referring to a number of years or the future age of the client. Imagine I'm sitting with a couple in their mid-40s and we start talking about saving for retirement. Rather than ask, "Where do you want to be at age 65?"—Still alive I hope—I ask: "Where do you want your portfolio to be 20 years from now?" That question yields the most precise answer and doesn't force us to face our own mortality.

Objectives in hand, now we can do some real work. I'll look at how much money the couple has accumulated, how much they're saving each year and how that may change in the future. I'll introduce expected rates of return for asset classes, select low cost index trackers to represent asset classes, and calculate the net expected return for their portfolio. Et voila, we have a plan!

Keeping The Plan On Target

This plan is valid as long as the couple implements it fully and maintains it diligentlyover the long term. Darn, I've said it again! At least I've established in this case that "long term" means 20 years. There's no expected deviation from this plan. It's expected to be the same asset allocation for the entire investment period. A strategic (or fixed) asset allocation is created and rebalancing is done on occasion to keep the portfolio on target.

This methodology is classic modern portfolio theory. We take past asset class risks and returns, make assessments about future risks and returns, add assumptions about correlations over the investment horizon, and come up with a prudent asset allocation recommendation. This allocation does not change unless something changes with the client. Discipline is what makes the strategy work.

We commonly use past asset class returns to show clients that stocks have outperformed bonds, bonds have outperformed cash equivalents, and cash equivalents are better than putting money in glass jars and burying them in the garden. Advisers also use these historic numbers to explain risk and return over varying periods of time.



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