Wealth Management

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January 3, 2019

The #1 threat to a client by their financial adviser

In managing a client's wealth, the threat of a client outliving their wealth is a far more serious failure than failing to grow the client's wealth at a maximum pace.

However, clients bring their many personal biases to the portfolio asset allocation recommended by the investment adviser. In fact, there are approximately 20 types of biases and even the genders tend to favour the same sets of biases. Each of these biases can seriously compromise a portfolio.

Going back to the question, what is the number one threat to a client by their advisor? The answer is if you are likely to run out of cash and have a hit on your life style.

For your Client Adviser, their challenge is to understand the client's biases and to be able to make sure they are not compromising the performancae of the portfolio.  For example, men tend to be over confident and load up on a stock that is sure to hit it out of the ball park - such as a crypto-currency or marijuana company. An excellent Client Adviser is paid to help you understand your biases and how your behavioural biases impact on the pace of growth of your wealth.  Your biases, if unchecked, could also seriously compromise your retirement money.

 It is how the allocation across your portfolio impacts the day-to-day living if there is a market crash.  Since the market volatility is increasing, this is an important question for anyone working with a Client Adviser to manage their wealth.

Do you really know and understand your own biases?

Your Client Advisor knows the 20 biases and have seen them in many combinations over the years of their career. This natural human behaviour - to follow your own bias - is exactly why you pay your Client Adviser. They are there to save you from your own human imperfections.

If an asset allocation performs poorly due to a client's bias, what will be the impact on their lifestyle? For the investors with $2M and under, the consequences could be dire.  For those with higher levels of wealth, the bias will not have the same consequences.

Every client brings their set of behavioral biases to the investment relationship with their Client Adviser (CA). Pompian and Longo recommend to CAs that they first determine how much they need to adapt to client bias which can be" irrational". As a suggestion, they advise weighing the rewards of sustaining a calculated, profit-maximizing allocation of assets against the possibility of upsetting the client if they try to educate the client about their biases and end up upsetting them instead. If the client is very wealthy, and insists on irrational decision making, there is far less risk for serious damage to lifestyle and retirement plans.

Clients are human and have their natural biases and may be wanting a completely different portfolio. When does the CA try to educate and to modify the client bias and when to let it go?

The key is to look at the worst case scenarios of the investments. If the worst markets happened, would the client run out of money? Would they outlive their cash supply?

If the answer is yes, the client would suffer, then the CA needs to do their job which is to protect the client from their behavioral biases. The CA needs to moderate the client's views on the asset allocation. It takes courage, but the CA needs to step up and explain the potential outcome to the client. Equally, a client needs to realize they are not seeing the whole picture and their Client Adviser may be making sense. Then, together, they can moderate their expectations for the portfolio.

If the client has substantial wealth and their day-to-day living would not be impacted by a market crash, then their biases could be accommodated. Overcoming sub-optimal impact of behavioral bias on portfolio returns becomes a lessor consideration. Adapting to, rather than moderating, the client's behavioural bias is then possible.