Is there a time when an investment advisor should challenge a client’s investing preference?
One of the first conversations between an advisor and their client focuses on how the client hopes to invest their money. Central to this conversation are two key issues: investment objective and investment risk.
Any investment strategy must incorporate these two, often conflicting, issues. For example: an individual might want to plan for a secure retirement, however, they are reluctant to take any significant investment risk.
Different people react differently to risk, and some have a strong bias against taking risk.
The client might inform the advisor they do not want their portfolio to suffer any losses during any year in the future. An automatic conclusion could be for the advisor to recommend 100% of the client’s portfolio be invested in Government of Canada bonds. Bonds are safe and there is little chance that there will be a negative return on any year in the future. But does an all-bond portfolio make sense?
From a risk prospective, investing in Government of Canada bonds satisfies the client’s wish to avoid investment risk.
However, in answer to the question asked at the beginning of this column, this is a situation where an investment advisor should challenge a client’s stated investment wishes.
A low return bond portfolio initiated to satisfy the goal of avoiding risk, would in fact result in the greater risk of not being prepared financially to fund retirement.
The problem with bonds today is that prevailing interest rates are very low and therefore in the long-term the growth of the bond portfolio would be minimal. That would not be a problem if the client was extremely affluent, or if they had already secured a retirement income due to a large pension.
Low interest rates, and therefore low portfolio growth, would not detract from an affluent client’s long-term objectives to prepare for retirement.
That being said, most people are not affluent and they don’t have a strong pension to support their desired retirement lifestyle.
Most individuals planning for retirement will be successful because they are able to save and invest those savings in order to generate a good rate of return. It’s the combination of savings rate and the rate of return that leads to their financial success.
Often developing a suitable portfolio requires a balancing act between different types of risk.
My recommendation is to carefully consider all your risks. In the example above an investment strategy built around a low risk bond portfolio would result in the larger risk of not being able to afford a desired standard of living during retirement.
Developing the appropriate investment strategy, taking into consideration all your various needs and risks, is essential.
It is normal when conflicting investment objectives occur but it is important that these differences be discussed in order to plan the appropriate investment strategy.