When thinking about clients’ retirement portfolios and client behavior, the best approach is to make portfolios decisions based on their life stages, from accumulation toward life goals, to the preservation of those goals, to distribution.
All too often, advisers are guided by the responses that clients provide on simple risk questionnaires, which are theoretically designed to assess the client’s risk/return preferences. But all too often, they only reflect the amount of downside volatility that investors can withstand without bailing on the portfolio altogether.
A goals-based portfolio, instead of driving asset allocation decision by short-term volatility, emphasizes two factors that are key for investors: time horizon or the amount of time they have to reach their goals; and probability of success or the likelihood of having the capital they need to make their goals a reality.
Goals-based investing addresses the investor’s entire lifecycle as it focuses on ensuring that the client can meet his or her primary objectives. A client who has a limited time horizon until he or she needs to start funding a goal will necessarily need a combination of asset classes that delivers very low volatility.
But a client with a defined goal that is 20 or more years away from actualization will benefit most from a combination of asset classes capable of generating the highest rates of return over that defined period, regardless of the volatility that may accompany that portfolio.
Of course, just because volatility doesn’t belong in the driver’s seat, it is always a key consideration, and risk mitigation becomes ever more important as the client approaches retirement. However, the differences between a goals-based approach to risk management and that of more traditional strategies offer important advantages to investors.
Risk mitigation tools can be used within the equity portion of a portfolio to dampen volatility.
When the stock market declines, an equity-based wealth protection strategy might gradually shift a portfolio toward investments that are less sensitive to severe market corrections. When those risk conditions have eased, the portfolio is gradually shifted back toward its growth-oriented position.
This is a different approach than simply loading up on fixed-income and cash-based investments as a client approaches retirement. Mitigating risk within the equity portion of the portfolio can allow clients to maintain a higher exposure to stocks over time, giving them the potential to continue earning higher rates of return than they could get from an increasingly bond-heavy portfolio.
This type of goals-based approach can add tremendous value and can help differentiate advisers who bring these capabilities to their clients.