When we think of investment advice, the first question almost always asked is “what’s the client’s risk profile”? Like Pavlov’s Dog, it’s almost a conditioned reflex to the way the industry has operated over so many years. Of course, it’s important to understand what type of investments the client would be ‘comfortable’ with, but does it really help them achieve their goals and is it really in their best interests to invest according to a risk profile questionnaire?
Some financial planners use the client’s risk profile because it’s “what we do” and the system / products are set up that way, but if we’re honest then the most important place to start when considering an investment portfolio should be the client’s actual investment objective. I mean, that’s what they come to us for, so that’s what we should be solving for.
The unfortunate reality is that almost never does a risk profile-based investment portfolio match up with reality. This is not surprising. Why would they – and if they did it would be more likely coincidence than reality. For example, take Holly who wants to grow her wealth by 6% per year to give her enough capital to retire, but she’s a bit nervous about investing because it’s not something she follows - the news is always so up-and-down. As such, her risk profile reveals her to be a conservative investor, which if we use current Lonsec target rates of return would be around 2.35% (Cash + 1.6%). Clearly her risk profile would put her into a portfolio well below what she needs. In this instance the risk profile approach would basically guarantee she wouldn’t meet her goals.
If that portfolio were to be implemented it would be very difficult for an adviser to reconcile how their advice meets the client’s interests. So, not only would the adviser likely fail the client, but they expose their business to the risks of not acting in the client’s best interest, something all planners are trying hard to avoid in a post-Hayne world.
The rational and ethical financial adviser would exclaim “Sorry, Holly there’s a gap between what you need and what you say you’re comfortable with, so, how do we address it?” Maybe Holly will need to accept more risk? Maybe Holly adjusts her plan by saving more, retiring later or reducing her income needs in retirement? Who knows how each conversation turns out, but that is exactly the type of conversation a financial planner should have when explaining how an investment portfolio is set-up. That is, the process is something like (1) what are your goals (2) these are the investment outcomes needed to achieve them (3) this is the portfolio we believe is likely to achieve that outcome and finally (4) this is how it matches up to your risk profile. This approach is the one most likely to meet the client’s goals and therefore be in their best interests.
We must remember that there are three things that drive clients to approach financial planners for advice. They are peace of mind, capital protection and capital growth. Leading financial planners know that central to any advice is the client goals. Smart and capable financial planners look at the client goals AND the accompanying solutions instead of relying on outdated approaches that likely do not meet the client’s needs.
Risk profiling is still an appropriate step to take when providing financial advice, but it should not be the determining factor for investment advice. It is the client’s goal that should be guiding our investment advice. By focusing on the client’s goals, ascertaining the required rate of return and starting an active, collaborative conversation with your client, you will be able to create quality, fit-for-purpose investment solutions that’s more likely to meet the needs of your clients. Now, that is putting the client’s ‘best interest’ first and helps differentiate a good adviser from the pack.
Goals Based Investing (GBI) uses Dynamic Asset Allocation (DAA) which works by ensuring portfolios remain focused on the achievement of the investor's goals – be it risk, growth or managing timing of cash flows.
Dynamic Asset can help you link your goals-based advice to goals-based investment portfolios through its unique Portfolio Construction tool. With its range of portfolios and team of experienced portfolio managers Dynamic Asset can provide ready-made solutions for advice businesses looking to help their clients achieve their goals.
Contact us to learn more about GBI and how Dynamic Asset can help you in your business.