In the face of a relentless bull market in equities, advisors have the difficult task to justify balanced allocations to clients who have grown increasingly ambitious on returns. As the memories of the 2008 crisis start to fade, investors have become less realistic and more greedy.
Financial advisors have stated that some their clients at the start of 2014 have demanded of them why don¹t you allocate more of my portfolio to stocks? Advisors have naturally justified their choices by pointing to the allocations agreed upon in the policy statement. Often this reasoning is insufficient to preserve the client¹s trust and satisfaction.
A mid-year review in 2014 now brings on the same line of questioning as financial advisors must manage their clients risk and expectations in a bull market. A recent study of mass affluent investors by AssetMark finds critical gaps in knowledge and expectations between advisors and their clients. Nearly half of the study respondents say they would risk 25 percent to 100 percent of their portfolios for commensurate returns, yet the vast majority claims to be moderate to low risk takers.
On a positive note, the study reveals that investors want to be more educated about risk by their advisors. However risk is difficult to measure and communicate. What is the best way to explain risk, negotiate risk/reward tradeoffs and set realistic expectations? Or would you rather have your client educate themselves on social media? After conversing with many financial advisors on this topic, it appears that judicious use of portfolio analytics backing your arguments with easy to understand metrics and rich visuals may significantly improve your communication and trust with clients. To create this valuable opportunity, you must become a story-teller to your client. The following three visual analytics will greatly educate your clients in a bull market:
• Present risk/reward visuals for long term periods. Over a 10 years or even 20 years horizon, balanced allocations have done nearly as well as pure equity portfolios but with less volatility. The risk/reward visual is simple to understand and puts risk and return on an equal footing. The risk metric used is typically the portfolio volatility. Astute investors may point out that volatility of investments going up in value (like recent equities) is a good thing. Explain that the faster an investment has gone up, the faster it can go down, so high volatility - even on the upside is a still a sign of risk. To drive the point home, highlight investments with high volatility on the upside in the tech sector of the stock market just before the crash of 2000.