During periods of market volatility and global economic uncertainty, it's not easy to deliver a decent return on investment portfolios consistently, especially during short time spans. In fact, it's nearly impossible.
That challenge is compounded, however, when high-net-worth clients have strong - and perhaps ill-founded - opinions about how their portfolio should be invested, and pressure their CPA financial advisors to direct their investments accordingly.
The good news is that seasoned advisors are almost always successful in preventing clients from committing financial suicide, while occasionally being forced to allow clients to shoot themselves in the foot.
"Everyone has a few clients who enjoy the pursuit of unique investment opportunities," said Ted Saneholtz, CPA/PFS, the founder and president of Summit Financial Strategies in Columbus, Ohio. "Sometimes they become so enthusiastic that they are blind to the risks."
He had a client who was determined to invest $2 million in a real estate development project. Saneholtz could not see any inherent flaws in the deal, but knew it would have left his client inadequately diversified. He persuaded the client to cut his stake to $400,000. Ultimately the investment did not pan out, and the client was grateful for being talked out of his original intention.
Another client sunk $250,000 in tech stocks (using a stock broker) at the peak of the tech bubble. "Did I try to talk him out of it? Yes. Did he listen? No," recalled Saneholtz. When the bubble burst, the client was left with only $20,000 in that account.
DRAWING THE LINE
The best way to avoid having to witness such disasters is to begin the client engagement with a thorough discovery process. On occasion, red flags appear immediately and lead to a decision not to take on a client prospect.
"If someone comes in saying, 'It's easy to get a 10 percent return,' we'll say that's not a reasonable expectation," said Ted Sarenski, CPA/PFS, of Blue Ocean Strategies Capital in Syracuse, N.Y. "If they continue to insist that it can be done, we'll just tell them we can't work with them."
In recent years, clients with unrealistically optimistic expectations (most of whom he has been able to work with) have tended to be people close to retirement with under-sized portfolios. "They'll say, 'I have to hit some home runs here'" to be able to retire based on their original timetable. Conversely, he has found younger clients, still traumatized by the experience of 2008-2009, going overboard in the other direction.
To bring clients into alignment with objectively realistic expectations and the investment strategy she recommends, Peggy Ruhlin, CPA/PFS, and her colleagues at Budros Ruhlin Rose in Columbus, Ohio, use a propriety system they call the Portfolio Design Blueprint. She begins by comparing the process of constructing a portfolio to designing a home or undergoing a major remodeling project.
Clients quickly concede that they wouldn't start a remodeling project with a trip to Home Depot and immediately beginning to pound in nails. The punch line to clients: "Your house is a large asset, but your retirement assets are more important. Don't you think it's worth the time you spent planning your kitchen remodeling to build your retirement portfolio?"
Once clients have embraced the importance of a deliberative approach to portfolio construction, they are open to receiving a thorough grounding in the investment characteristics of basic asset classes and a discussion of their goals, time horizon and risk tolerance.
The end result is an asset allocation model and a one-page investment policy statement. "It lays out, 'Here is your target allocation. Here is how often we are going to rebalance it. Here is how we are going to judge performance,'" Ruhlin said.
Clients literally sign on to the IPS, putting their signature on the document so there can be no questions about their expressed intentions down the road if the client suddenly wants to make a large investment that would effectively throw the plan out the window.
Sarenski, during his initial conversations with clients about asset classes and their investment performance track records, tries to engage them on an emotional level as well as simply laying out the facts. "I will ask, 'What if you had [invested in a particular category of investment] at that time?'" The hope is to condition clients, for example, not to panic and pull out of the market at the bleakest hour - which might turn out to be the bottom.
Blunt talk with clients is often appropriate to prompt them to think. Glenda Moelenbah, CPA, of Financial Bridges in San Diego, recalled a line used by a dentist to encourage compliance with the standard instruction of routine flossing: "Just floss the ones you want to keep."
When a client recently informed Sarenski of his intention to retire in three years as a rationale for having his entire portfolio invested in bonds immediately, Sarenski's reply was, "Do you plan to die in three years?"
The comment primed the client for the topic of how long a portfolio will need to hold up through retirement, the inevitable investment cycles and the corrosive impact of inflation that a bond portfolio (especially in today's low-interest-rate environment) cannot protect against.
Tough talk by Saneholtz may have helped to persuade his client to cut his planned $2 million real estate development investment to $400,000. He asked the client, "If this doesn't turn out the way you hope, is personal bankruptcy something you're willing to experience?"
But zingers must be part of a broader discussion of the potential tradeoffs inherent in a decision that the advisor is trying to talk a client out of. "If a client insists [on a risky investment], we will discuss whether they are willing to work longer or save more if it doesn't work out," said Cynthia Turoski, CPA/PFS, of Bonadio Wealth Advisors in Upstate New York.
It is possible to be very specific with clients about the implications of an adverse outcome on a particular investment, such as by projecting the additional years an investor would need to work before retiring, given a particular set of assumptions, to recoup a loss, or, conversely, to offset the impact of predictably low returns on a portfolio built on an unduly conservative asset allocation.
'FAT' IN THE BUDGET
When dealing with high-net-worth clients, however, it may not be necessary to try to advise against an imprudent investment. For example, if a client is already giving away hundreds of thousands of dollars annually to charities and children, "I might be more flexible, because there is fat in the budget," Saneholtz said.
He uses Monte Carlo simulations to help estimate portfolio growth, and generally looks for an 85 percent success probability in constructing that portfolio. But when there is "fat in the budget," he is comfortable with only a 70 percent success probability.
A related approach is simply to consider the "mad money" that clients use for pet investments as independent of the basic portfolio, and make asset allocation and investment planning decisions entirely without regard to those "external" investments. That may require an overhaul of the basic portfolio, however.
A middle ground, if the relative size of that independent investment is too large to ignore for overall investment planning purposes, is to incorporate it into consideration of the aggregate portfolio allocation. When a client of Chicago-based advisor Paul Sippil, CPA, insisted on investing 10 percent of his assets in several industry sector exchange-traded funds, Sippil rebalanced the remaining 90 percent accordingly.
One of the trickier investment scenarios that advisors may confront involves clients who want to support a family member in a business venture. "The emotional implications for the client complicate your ability to discuss the investment with them analytically," noted Saneholtz.
RETURN TO GOALS
The approach Ruhlin uses in such situations is the same one she uses with other potentially problematic investments: "You take the conversation back to their goals," she said. "I'll say, for example, 'You have told us you want to retire in three years. Have you changed your goals?'"
Ideally, clients' goals and the investment policy statement built on those goals should be reviewed every year or two, so that the advisor has a strong basis to assume that such an investment would indeed be at odds with client objectives.
In the case of a prospective family-related investment, clients often are happy simply to let the advisor play the role of "bad cop," Ruhlin said. "They can tell the family member, 'I'd love to do it but my advisor says I can't afford it.'"
But when clients proceed with such an investment, or simply fail to act upon any other recommendation, a little reflection may be in order. "I ask myself, 'Why did they do it?'" said Moelenbah.
Not content simply to put the blame on the client, she considers ways she might be more successful the next time around. Often she concludes that she may have overloaded the client with advice or tasks. "Sometimes it helps if I just give them one thing to do until our next meeting," she said.
She is also careful to document her advice, so that clients who defy it cannot deny that they received it if they are unhappy with the consequences of their failure to heed her recommendations.
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