For those working in PWM: How are client's risk tolerance and goals translated into a portfolio? Is market risk a consideration in the portfolio construction process?
Aug 13, 2019
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Risk tolerance is taken into consideration. With that said, from what I mostly see across the industry it's something along the lines of a set portfolio with different allocations to mutual funds and ETF's, and the only thing that changes is total percent allocated to fixed income vs. equity funds. Outside of the prop portfolio's ran by the team, they deploy the rest of the clients capital in alts, and managed strategies based on the clients goals/needs. These vary from aggressive risk tolerance translating into growth/small cap/alt strategies, and the more conservative being in fixed income/dividend-value focused portfolios.
Market risk is monitored and adjusted to some degree, but in my experience not very proactively.
I wish this was a simple answer, but it’s not. Gauging risk tolerance is incredibly difficult, and questionnaires are used more to appease regulators than actually get to know someone. You have to probe, asking about how they currently invest, what are some money experiences they’ve had, and so on. I’ve seen 70 year olds with 100% stock portfolios and 40 year olds sitting on 100% cash both describe themselves as conservative. It’s complex to get this roughly right, but not difficult once you get the hang of it
Goals that are spending based go into how much equity exposure one can take. For example, if you have a pension that covers all your needs except maybe a modest draw off the portfolio calls for a different amount of equity exposure than someone with $500k needing $80k a year and maybe has 10 years to live. Also depends on their views of leaving a legacy, charitable intent, etc. Specifically, the farther out a goal is, the more risk you can take. I’m investing someone’s money set aside for property taxes differently than their grandchild’s 529.
On market risk, yes but anyone who believes in and uses MPT as the way to determine allocation is likely the most boring person at the one party they’re invited to annually, it’s fine conceptually, but it’s not practical at all.
Hope this helps
^Excellent and very real post! I deal with this all the time. It's totally subjective based on client wishes and concerns. Once they've already accumulated funds, which is most who I deal with, it's about spending, legacy, gifting and tax strategies. What do they want to achieve with their assets? My portfolio vs. your portfolio isn't that relevant anymore. Financial planning and money management are two very different things.
Thanks thebrofessor - I appreciate your response!
A follow up question: when handling client spending needs, how common is the use of bucketing strategies to avoid selling equities when they're down ( and instead selling from cash or fixed income buckets)?
I use the bucket approach (and latter approach) for practical planning discussions / design. Set up income streams for different timeframes using different buckets. Gives a lot of structure to their planning. Take $X from Bucket A for 5 yrs, B for 10, C for 15, D for life, etc. Each Bucket has its own characteristics with respect to liquidity, taxation, risk tolerance, etc. That's why I say financial planning / PWM is about a lot more than asset management. That's more about portfolio construction. Honestly, i barely discuss portfolio construction with clients. That's more internal so We decide what holdings belong in each bucket. Client doesn't really care about that detail.
Makes sense - thanks for your response rickle!
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