Tips For CFPs Looking To Building A Portfolio For Clients

Depending on the age and risk assessment of your clients, how should their portfolios differ?

The conventional wisdom says that investment portfolios should be designed around the age and risk tolerance of each individual client. But experts say this approach is oversimplified.

"It is impossible to reduce a client to age and risk tolerance, though Wall Street tries incredibly hard to do this because it makes answering tough questions so much easier," says Jonathan DeYoe, a Certified Private Wealth Advisor and an Accredited Investment Fiduciary with DeYoe Wealth Management in Berkeley, California.

If age and risk tolerance serve as incorrect or incomplete guidelines, what should financial planners base portfolio construction on instead? Most experts say CFPs should consider a more personalized approach to building portfolios for individual clients. This article will also consider a dissenting viewpoint.

Tip 1: Don't link risk tolerance to age, and focus on investment goals and liquidity needs
"I have seen very conservative investors panic when their portfolios experienced higher volatility because they were told to be more aggressive because of their age," says Tim Higgins, CFP and ChFC with 3MERITUS Wealth Management in Southborough, Massachusetts. "The end result is they sell when their portfolio is down and now it will take longer to build that portfolio back up."

"Anticipated liquidity needs and the losses an investor can stomach should drive asset allocation decisions," says Zach Han, a CFP at Moneta Group, a St. Louis-based registered investment advisor.

"The commonly used theory that young investors can afford and therefore should assume more risk, while at times appropriate, shouldn't be the end-all, be-all yardstick for risk exposure," he says. Investors of any age are not going to feel good about losing a significant portion of their portfolios if the markets have a bad year. Such an experience can even give younger investors a bad taste for the market.

Similarly, the conventional wisdom about putting older investors in lower-yield investments isn't always the right choice.

"Older investors often feel uneasy about the security of a portfolio that is overexposed to fixed income, netting very low yields at a time when cash needs may arise unpredictably," Han says.

"In the end, clients want a series of outcomes . . . move to a new house, buy a new car, send their kids to college, take that once in a lifetime vacation, [accumulate] retirement income they can't outlive," DeYoe says. "Clients need to understand the tradeoffs required to meet their goals and believe in the long-term plan," he says.

Tip 2: Don't rely on risk-assessment questionnaires
Han says developing an understanding of a client's overall attitudes and beliefs about money can't be achieved with a simple questionnaire. This task requires a candid conversation between the client and the advisor.

"Individuals' opinions on money, risk and investing are informed by unique experiences and circumstances and can only be identified by asking tough questions and sometimes challenging clients' responses," he says.

DeYoe adds, "The conversation that so often happens around, 'How do you feel about losing 40% of your portfolio in a single year?' is intellectually dishonest. No one wants to lose 40% of their portfolios in any year."

The only way to take very little portfolio risk, however, is if a client has either very low future expectations or a higher than normal income that they can save a large percentage of, DeYoe says. Most people have higher expectations than their incomes can support, so they must understand the need to take additional portfolio risk or cut back on spending.

Tip 3: Minimize volatility and losses
Our experts say very few investors are comfortable with volatility or losses, regardless of what they might say or think while filling out a questionnaire, when none of their capital is actually at stake.

Higgins says he always allocates a portion of the portfolio to alternatives that are less correlated to stocks and bonds because these can provide less volatility for clients.

Jeff Camarda, a CFP and CFA in Fleming Island, Fla., oversees more than 10 portfolios as CIO of Camarda Wealth. He says that while most planners measure risk tolerance, fewer seem to pay attention to clients' preferred investment style.

"Since 2008 many investors - particularly those in or near retirement - have had their risk/reward circuits rewired. They are much more cautious, and we have found that whatever their measured risk tolerance, they much prefer investments with lower perceived risk," he says.

Camarda adds that bonds are riskier than most investors realize, and for retirees, his firm prefers conservative stocks paying regular dividends because clients like the regular income.

"We also use proactive loss control techniques like stop loss orders for these clients, which gives investors real peace of mind. No one wants to live through 2008 again," he adds.

Tip 4: Communicate continuously with your clients
"No portfolio design will ever be effective if there is no clear, continuous communication with the client to make sure they [sic] are comfortable with the level of risk and diversification within their portfolio," says Henk Pieters, MBA, CFP and president of Investus Financial Planning in Newport Beach, California.

Pieters reviews his clients' risk assessments with them once a year or when significant life changes occur and when major market movements happen. In constructing the portfolio that will maximize return for the amount of risk taken, he looks at the client's overall risk management and exposure, life goals, risk tolerance and risk capacity.

Pieters says if he has a 50 year-old male client who is conservative, might have to support his elderly parents and has communicated that he panicked and sold all his stock in the correction of 2008, he will modify the traditional allocation recommended for this investor's age, 50% in stock and 50% in bonds and cash, to make it more conservative.

He also makes sure to continuously communicate with his clients, who can sometimes be emotional, ill-informed or dealing with information overload. He wants to make sure they understand that their portfolio's risk exposure is designed to build long-term wealth.

Tip 5: Consider alternative strategies
Jonathan Citrin, founder and CEO of the Citrin Group investment firm in Birmingham, Mich., and an adjunct professor of finance at Wayne State University, feels very strongly that advisors must not custom tailor portfolios to individual clients based on age and risk tolerance.

"For managers and investors alike, there is clearly one model portfolio that yields the highest amount of return per risk taken - the optimal portfolio," he says. "All managers should offer only the optimal portfolio and preach to their clients the need to determine the amount of risk in the system - rather than the misleading albeit customized portfolio offerings too many push these days."

Citrin says financial planners turned to portfolio customization and personalized relationships to justify their fees when the Internet obliterated any form of transactional business. This new business model created a major problem: "Managers increased the number of assets they must oversee at any given time and rendered themselves incapable of giving sound advice," he says.

Citrin says shifting a few assets around can leave investors with a portfolio that is riskier than it seems on the surface. On the other hand, a basket of risky assets that are properly allocated based on correlations, as premised by modern portfolio theory, can actually be much less risky.

"One cannot overlook the rules of risk and reward, and that of correlations, to simply appease a certain client," Citrin says.

The Bottom Line
Different financial planners may not completely agree on how to best design portfolios for individual clients. But they can all provide security in another way.

"A steady, disciplined rebalancing strategy, one not dictated by euphoria in good markets or paranoia in downtimes, can help propel successful investment portfolios," says Han. "That's when having an advisor you can trust - someone to help you avoid emotional decisions - is critical."

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