We have been counseling individuals and families for more than 25 years, and it has always been interesting to see how people narrowly apply the common wisdom that a person's age is the rule of asset allocation between stocks and bonds. For example, if you are 20, you place 80% in equities and 20% in bonds; if 50, you place 50% in equities, 50% in bonds and so on.
As the financial services industry continues to evolve, real estate, hedge funds and commodities have become standard parts of the allocation equation. And while many advisers may be knowledgeable about some or all of these products, how thoroughly do most get to know their clients and attempt to understand those clients' emotional bandwidth and business acumen?
Their experiences could forever affect their “emotional intelligence” and investing style.
Moreover, are there wills in place that accurately represent the needs of clients and their families? Is life insurance properly crafted? Do the clients' children understand their parents' wishes, and will they respect them so that lawsuits don't follow clients to the grave?
Knowing your clients' family and emotional history is a key to making long-term investment decisions and to building a successful practice.
Take, for example, Ralph: He is 52, married, builds homes for a living and has two teenage daughters. His business is very sensitive to the overall economy.
Further, Ralph's grandfather lost all of his money in the meltdown of 1929, an event that has ingrained in Ralph's psyche the notion that stocks are bad, municipal bonds are the only investment to make, and hedge funds — well, who knows?
Ralph needs access to capital (because he is in the real estate business) at all intervals, as his business, during good times or bad, always requires liquidity. In addition, he has no emotional capability to deal with volatility in the markets — he loses sleep no matter what he invests in if it is volatile.
Finally, if Ralph were to become disabled or die, it could be ruinous to his family business.
Contrast this with Mary, a manufacturer, who is 46. She has a patented product that is a necessary staple in people's homes.
Mary's business is less transactional than Ralph's because her product is a necessity. She had a father who “lived the market,” and Mary loves to take risk and is totally entrepreneurial about her life.
She has never made money sitting still, and her business is valuable whether she is disabled, alive or dead.
Ralph and Mary come from different places as it relates to investing. Tactically, the adviser should try to evaluate each of them as individuals, taking into consideration not only financial and age differences but also significant cognitive, behavioral and emotional differences.
When advisers meet with a client, they should try to understand through a personal interview, both verbally and through body language, what the response might be to certain concepts or investments. The client who truly knows himself or herself is very rare, and it is important to establish what the client may perceive to be his or her appetite for risk and volatility.
Not only will it help the client, but equally as important, it will help the adviser do the best job possible.
Volatility is inevitable in investing. As such, it is critical for an adviser to help a client understand that volatility can be his or her friend or enemy.
But remember, it isn't possible to keep a client emotionally comfortable at all times, no matter what.
In our example, Ralph will look at the high returns that Mary may be getting on her portfolio and complain because he wants the upside. She will also complain when the volatility extends beyond her comfort zone and will decide to throw in the towel.
The adviser should monitor situations on the basis of clients' emotional states and on clients' ability to tolerate tactical objectives. The latter requires clients to understand what they give up and what they get when they accept certain asset allocation recommendations.
Recent volatility has made tactical-allocation analysis even more important because emotional swings are more common in today's stressful economic environment.
Moreover, understanding the effects of these emotional stresses very often calls for insight that is much more in sync with the client than just the usual financial “suitability” review. Unless we are willing to spend the time really understanding clients' needs, we can't be fully appreciated as investment professionals.
It isn't just about the money; it is about the people.
Seymour W. Zises and Andrea L. Tessler are co-founders of Family Management Corp., a wealth management firm.
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