A FINANCIAL PLANNING ALGORITHM

Dozens of books and hundreds of papers have been written about asset allocation and financial planning models. And although some details and technicalities can be very interesting and thought provoking, in real world conversations with potential clients, time is limited and precious. Private bankers need to inform, educate and provide helpful advice in a very short amount of time. Ideally, they act as teachers and guides but both parties can’t be expected to take a week off and enjoy a crash course in financial markets. So given these limited resources, what should a private banker do?
Well, he has to work methodologically, to the point and faster than ideally acceptable. The more time he has, the better of course. The more conversations, the better. But as we said, time is scarce and the attention span of a potential client can be short as well. In what follows we provide a simple plan to provide the most honest and correct advice as fast as possible. We make the assumption that the client wants discretionary management,  not advisory. We believe it to be a excellent example of how we like to work.

Before your begin – Be straightforward. Your job is to be as practical and helpful as possible, small talk is for later. 

  • Tell your contact that you would like to respect each other’s time and work schematically. Ask him to put up with you for 1 hour.  Show him visually the steps you will follow on a one- pager.  That way, he is prepared to cooperate as efficiently as possible.


Step 1 – 10 minutes: Present the firm in a short and concise manner

  • Present your firm with a focus on history, vision, safety, team, services, fees and a special focus on what makes your asset management firm different from all the others. Make sure it’s not an exaggerated marketing pitch and point out the win-win situation for both parties where achieving the long term goal(s) of the prospective client is key.


Step 2 – 30 minutes:  Current Asset Allocation and Firm View

  • Ask the prospective client to be open about his current asset allocation; preferably as detailed as possible. Why? Only then can we make sensible future assumptions. You want to know the allocations in real estate, equity, fixed income, commodities, private equity, venture capital, cash and hedge funds.
  • Ask your contact to be open about portfolios held with other institutions. You are especially interested in the Equity/Fixed Income allocations and regional allocations. Why? In order for you to be able to present correct solutions, you need to be aware of this.  If your client has huge emerging market exposure with some other asset manager,  it doesn’t really make sense to offer him that exposure as well, except maybe for reasons of asset manager diversification.
  • Plug in the asset allocations (assets and regions if provided) in your financial planning calculator. Tell your potential client that your firm has a long term view on every asset class supported by statistical and historical evidence. Also, keep it honest and inform him that these views are still just assumptions and that deviations can and will be possible but that the assumptions are as solid as possible given the available information we have today (valuations, yield levels, default levels,…). Practically, this means that you have to plug in, present and explain the following numbers: expected long term returns per asset class (and why), expected long term volatilities, expected drawdown based on history.
  • Visualize the possible ranges of the trajectory of his current wealth in a longer term framework. Pay special attention to possible drawdowns & recovery periods and inquire whether he can accept these risks. The prospective client’s risk appetite and tolerance depends also on his financial markets experience and is different for every individual. It’s his risk tolerance and moreover its translation towards his asset allocation that will make or break the realization of his long term goals. A client that experiences a drawdown that is bigger than his risk tolerance will act on his emotions and therefore, will make bad investing decisions like quitting the strategy (with possible loss) resulting in a disillusioned client and even worse, a client who will not achieve his long term goal.   
  • Inquire if he has some goals in terms of higher future capital needs or lower risk needs. Propose a change in asset allocation if needed, redraw the trajectory and see if he has a better feeling towards it. Pay special attention to risk-aversion again.
  • If the (new) starting allocation is determined, inform your prospect that:
    • He should only change this allocation if
      • Material changes in his life happen: heritance, higher salary, longer or shorter investment horizons,…
      • Markets have moved considerably so that the expected long term returns – due to material changes in valuations – have changed  substantially.
      • He can live with the new risk profile and confidence interval. It's no use, whatsoever, to allocate even a bit more to equities if the client indicates he will panic when the drawdown comes. Be honest and open about this.

 
Step 3 – 30 minutes:  Present possible portfolios

  • If the prospective client has allocations with other institutions, determine together where you can fill in the gap. Pay special attention to how your portfolios differ from the competition (fees, management, investment horizon, regions,…). If not, proceed directly to your possible portfolio solutions.
  • If the prospect has no preference for regions, instruments, styles and the knowledge base is relatively low: propose the most sensible solution out there: a global diversified etf-based portfolio styled towards his risk aversion. This is a portfolio diversified across several regions, countries, sectors and styles (dividend,…).
  • As soon as the client has a preference for a certain region, management style or instrument you can offer more of your tailor-made portfolios:
    • A portfolio with an overweight in certain regions or countries.
    • A portfolio with individual equities and bonds or trackers.
    • A portfolio with a buy and hold approach or a more active management style.
    • A portfolio with an overweight in a certain factor (dividend, value, momentum, size,…)
  • Conclude by pointing out the importance of underperformance. It’s imperative to alert a client that as soon as his portfolio has a certain overweight in a certain region, style or method he must accept underperformance during certain periods. Underperformance that lasts years in a row is no exception. A survey of the best fund managers ever, found that even they experienced slumps that lasted up to 5 years. The idea that a portfolio can outperform a benchmark each and every year is totally bogus and financial marketing chitchat. Be open about this with your client. Explain to him the most important rule of today’s financial markets:

 
“If there was a way to outperform the market on a consistent basis, everybody would do it. There is none. Stop looking for it. Everything moves in cycles. Underperformance leads to outperformance and vice versa. There is hardly any consistency in persistence of fund returns. Today’s markets are highly efficient: Hundreds of thousands of analysts, traders, computers, portfolio managers, hedge fund managers and high frequency funds scan the markets every nanosecond for opportunities.  Most of these professionals underperform. The only thing left that can help deliver risk-adjusted excess returns is ‘time-arbitrage’. The market is so efficient that it will look and probably find your pain threshold. We know that certain styles such as value/dividend/momentum/quality/size do work in the long run but the market will make sure that years of underperformance will lead investors to abandon the strategy. Only disciplined long term investors will be rewarded. Time-horizon, more than ever, is probably and of the few edges left in today’s computerized environment.”
 
Step 4 - 5 minutes:  inform your client about the goal of future conversations 
The goal of future conversations is only threefold  

  1. To dedicate a necessary but short amount of time to portfolio performance, benchmark performance, portfolio actions, portfolio views,…
  2. To dedicate a necessary but longer amount of time to financial education if your client is open to this. Inform him that the only way to win in financial markets is to be educated about noise and relevance. The only way for wealth management clients to have trust in you and their portfolio is to be educated about important topics such as: asset allocation, valuations and the impact on future returns, risk, factor styles, active versus passive, market timing, global diversification, market history, financial planning,
  3. Inform your client that constant market chatter is to be reserved for the ‘old school players’ who like to pretend and think that the daily noise matters. Most of the time it does not. What you want to achieve is wealth management 2.0: out with the old way of thinking, in with the new evidence-based way of thinking.