Investment performance vs. financial planning

By John Page | September 23, 2013 | Last updated on September 23, 2013
7 min read

Some clients will be out of the door in a hurry if their investment expectations aren’t met. If you have ever experienced even a small stampede for the door, you should ask yourself, “Have you led the client to believe that your primary role was to select products to meet their investment objectives?”

If the answer is yes, you may have set yourself up for failure.

A more prudent approach would be to position yourself as a problem solver. Make it your primary role to be someone who gives advice on how to best reach their goals — regardless of what is happening in the market.

Investment performance is obviously part of the financial planning equation, but it’s the part that we least control. That isn’t to say that this mitigates the need for us to use well-defined investment principles and processes, but lack of control of the markets is a constant.

Knowing that, why is it that many of us allow ourselves to be backed into a corner to meet our clients’ often irrational investment expectations? You know the clients I mean — the ones who want continually good performance with no negative years.

Could it be because for many of us trailers and commissions form a big part of our compensation? Thus we tend to focus on keeping clients happy primarily by getting good investment performance. In fact, in our anxiety to always “perform,” some of us even fall victim to chasing investment performance ourselves — even when we know that it’s a mugs game.

If this sounds like you, when performance tanks you have to resort to reciting these traditional mantras: “We have been through this before, the market will come back, it always has.” “Joe, if you compare how you have done to the overall market decline, you are really doing well.”

But Joe doesn’t buy your explanations. His confidence in you is badly shaken. Although his expectations may be unrealistic, they are his reality. And somehow you allowed yourself to be measured based primarily on investment performance.

Fortunately, more advisors are recognizing that there is a way to keep clients happy with the services they provide, despite erratic investment performance. It’s about changing the benchmark by which you are measured. The benchmark should be tied to helping clients get what they want in life. That means that no matter what happens, the client can count on you, even if it’s just making the best of a bad situation.

To know what clients want, you need to first know what they really value in life. You need to know about their life objectives and their tolerance for various types of investment risk. Then you build a financial plan to give them the highest probability of reaching those objectives while remaining true to their values. I call this enhancing their wealth.

Here’s one definition of wealth from Webster’s Dictionary: “the things that are most important to you.” So when I find out what wealth means for a client, I want to help them create an abundance of whatever that is. Will it be a specific amount of money? No, in fact, I have never had a client who ranked money as number one. What’s most important to people are things like their families, friends, health, career, or even spirituality.

When a client engages me as their primary financial advisor, my mandate is clear: Design a plan to take the client from where they are today to where they would like to be. The plan needs to give them the highest probability of reaching their objectives. The plan must also give them more time to focus on what matters most to them.

Let’s look at one of my clients whom I’ll call Bill. Bill’s main goal is to retire from working by 55 so that he and his wife, Joan, are able to travel extensively and spend lots of time with their grandchildren.

But before getting to retirement, it’s important that they control the amount of time that they work so they have can stay in shape and be actively involved in their community. They also want to enjoy their cottage, which they hope to have paid off before they retire so it can remain in their family for their kids and grandkids.

We estimated that Bill and Joan will need $6,000 per month (net after tax stated in today’s dollars) indexed to 3% inflation. To be safe, we planned to have that income to Bill’s age 100 — with a $250,000 cushion (in today’s dollars).

Investment performance is important to the plan, but it’s only one of the means for helping them achieve their goals, and they know that. They know that we cannot control investment performance, but we will always follow the principles and processes outlined in their investment policy statement.

We helped Bill and Joan find the money that will allow them to save $17,500 per year. Bill’s portfolio follows an asset allocation model that has historically delivered 7.38% annually. Based on these facts and a number of standard planning assumptions, Bill is told that when he retires in 12 years, he and Joan will be able to spend up to $6,000 per month (net, after tax and indexed to inflation to age 100).

Bill also should be in a position to attain all of his other lesser financial objectives. And, as a buffer, at age 100, there should be an estate left over of $250,000. This is all based on a number of well- thought-out assumptions.

But because nothing is certain in life we run Bill and Joan’s numbers through a reliability forecaster that we use. Basically it tells us that Bill and Joan have an 89% certainty of achieving their objectives. To increase the odds, they could save more, retire later, get better investment returns or move to a tax-free haven (they laughed at that idea). They were comfortable with the plan as is.

Then, not unlike the situation we’re in today, their portfolio lost over 22% of its value over the period of a year. In doing a review we presented Bill and Joan with some options. Bill could work two years longer than anticipated and he should have the same income. Alternatively, he could take $650 per month less in retirement income and still retire as planned. If neither of those options sat well with Bill, we could also allow his estate surplus to shrink to $98,000 (from $250,000).

However, we suggested that no action needs be taken immediately other than some minor portfolio rebalancing. We can look at their situation in 12 months and we will still have plenty of time to adjust their strategy. As a preventative measure, I suggest that Bill begin to enhance his savings by 5% a year more than we had planned. That won’t fully act as a replacement for the current drop, but it will be a step in the right direction.

In the end, we suggested that there is no reason to panic. We fully anticipated that roughly one in every 20 years we will have market results like this (that’s what our past performance data tells us). Bill and Joan knew that. What made them feel good was even if there was no big spurt in the market, they knew that we could create a plan for them. They are confident that by working together they will have the highest probability of reaching their goals. Bill and Joan also know that in addition to monitoring their portfolios, each year we will:

  • Recommend saving strategies. We go over how much they should save (or when retired how much they can spend). If things are tight, we will help find money in their budget to save what they need to. They know that we prefer never to suggest to someone that they need to reduce their lifestyle, unless they really must.
  • Control money management expenses. Performance we can’t control, but expenses we can control. We’ll never rebalance needlessly to trigger taxes, and that we may rebalance to soak up losses.
  • Reduce taxes. First we will look for deductions or credits. Next we’ll look to incur minimal tax on the portfolio by adjusting type of income, as appropriate. Then we will look for any deferral opportunities, and lastly, look for any ways to have income taxed in the hands of the family member with the lowest possible income. It’s amazing the many situations in which we can reduce taxes by thousands.
  • Anticipate cash flow requirements. We will make certain they have adequate liquidity to avoid liquidation at the wrong time.
  • Protect net worth. We will be certain that they are protected from an interruption of income as a result of disability or critical illness. It’s important to make sure there are adequate funds to protect erosion of what they have accumulated.
  • Keep estate affairs organized. We will suggest any changes that need to be made as the life evolves.

This approach goes a long way to mitigate any pain that clients may be feeling when the market tanks. That is because as an “advisor” you established a new benchmark — based on your ability to help them plan, not based on investment performance.

John A. Page, R.F.P., CFP, is a senior advisor at Page & Associates and the president of Wealth Enhancement Academy.

John Page