The role of wealth management

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The role of wealth management is to provide a road map to a client’s financial success. 

That road is constructed with the aid of decades of research from two opposing camps: investment theory and behavioral finance. Successful navigation means using what has been learned from both bodies of research. 

The first is investment theory about what works and, therefore, how you should invest.  This is referred to as modern portfolio theory and the efficient-market hypothesis. Consider this to be a practical hands-on guide to the types of investment strategies that will be useful in your personal investing efforts.  

Knowledge is essential when constructing an investment portfolio. Start by determining your target return on investment.  This is based on the arithmetic of investing. How much money do you have to invest and how much money will you be able to save and add to your investments?

If you have a financial goal to accumulate a specific amount of money by a certain time, that is a combination of how much you invest and the return on investment that is needed for you to reach that financial goal.

The return on investment is your target return. The idea is to achieve a desired target rate of return with as little risk as possible. That leads to the decision on how to allocate your investment dollars between stocks and bonds.

Stocks are more risky than bonds but over a long period of time will likely provide better returns. Bonds are used to lessen volatility. They most likely will have a lower return. It is the weighting of the number of stocks and bonds that is the single most important factor in determining the eventual return on investment.

The efficient-market hypothesis says the value of stocks as determined by the market is the correct way to value a stock. Thinking you can outsmart the market by selecting specific stocks because they are undervalued is not supported by academic investment research or market performance history.

The preferred way to invest is to own a broadly diversified collection of stocks that represent the market in which you want to invest. This should be done at as low a cost as possible. 

All of this is the rational side of investing which can hit a speed bump called behavioral finance where human emotional swings replace any foundation of investment logic.

The theory about how to invest can easily disappear. Human nature can hurt investment performance. Short-term reactionary decisions are made when long-term discipline is needed. 

After a logical and sound financial plan is developed, it is only a matter of time before short-term emotional decisions based on stock market swings motivate us to ignore the original long-term approach. That is reality and it happens all the time. 

Wealth managers can help clients articulate and define their financial objectives. What is important in their lives? How much money is needed for them to be able to achieve their objectives?

Then, the wealth manager’s role is to bridge the gap between the theories on how best to invest and then help clients understand the reality of how emotional investing decisions have led to historically poor investing results.

Consider a wealth manager as a financial coach. They understand what you are trying to achieve. Using all of their investment and behavioral personal skills they can help you reach your goal.