Your investment philosophy is like a ‘north star’, a reference point for the investment decisions you make on behalf of your clients. It should be deeply considered, and highly personal, reflecting your your own beliefs about the way investment markets behave, and working hand in hand with your overall philosophy on advice. Importantly, your investment philosophy should also be flexible enough to allow you to tailor investment portfolios to the unique objectives, risk profile, and time horizons of each individual client.
In this article, we will explore in more detail the importance of aligning your investment and advice philosophies, and the principles sitting underneath an investment philosophy that allow it to be applied consistently across a wide range of client groups and scenarios.
A range of potential investment philosophies as diverse as your clients
While your investment philosophy will ultimately be unique to you and your own beliefs, skills, resource constraints, and target clients, there are nevertheless several overarching categories within which an investment philosophy might fit. Examples include, but are not limited to:
Active or passive
• Reflects your own beliefs about the efficiency of markets and the importance of benchmarks
Asset allocation based
• Strategic asset allocation is premised on the belief that long term asset allocation drives most returns
• Dynamic asset allocation seeks to optimise asset allocation by making short term adjustments reflecting market conditions
• Age based
• Core and satellite
• Risk budgeting
Investment style based
• Factors (quality, value, momentum)
• Thematic
Sustainable investing
Aligning your investment philosophy with your advice philosophy
Your philosophy on advice and investing will be intrinsically linked.
For example, a conventional advice philosophy might be one which is investment-led, and heavily influenced by risk profiling. An adviser adopting this philosophy might believe:
• Psychometric risk profiling, to determine the clients appetite for gain and loss, is the best way to determine an investment strategy
• Risk means volatility of capital
• Markets are efficient and repeatable, and so optimal portfolios can be built using historical data
• Over the long term, clients are always adequately rewarded for risk
• Eventually all markets and managers are mean reverting, so the true value add in a more dynamic approach is likely to be minimal and not justify the extra risk and cost
This adviser might adopt an investment philosophy based on Strategic Asset Allocation (SAA).
On the other hand, an advice philosophy based on goals-based advice might be characterised by the following beliefs:
• Investors actual needs and goals are the most important building block of an investment strategy
• Risk is the likelihood of not meeting an investors’ goals
• Investors will have numerous different goals – so a one strategy fits all is not possible
• Markets are not always efficient and will not always perform as they have historically
• The world is in a state of constant flux – a more flexible, and dynamic approach can do more to drive growth or minimise losses
An adviser subscribing to these beliefs is more likely to skew towards a more active/dynamic approach to investing.
A word about risk
Constructing a portfolio based on differing client circumstances and needs – within a given investment philosophy – requires close attention to be paid to the nature of risk.
1. Risk capacity is critical
A person’s willingness to take risk is not as important as their ability to take risk. For example, a younger client may be very tolerant to risk but may lack the financial capacity to actually take any, which could take you down the path of a more conservative path than may otherwise have been the case.
2. Only take the amount of risk that is necessary
Similar to the point above, the clients objectives are just as important in determining the risk to be taken. Put simply, just because a client is willing and able to take risk, doesn’t mean they necessarily should.
Understanding Client Demographics
While the theoretical starting point for a unique client portfolio is a blank sheet of paper, in reality different client groups are more than likely to share similar characteristics, especially in terms of investment horizons, objectives and risks. Sequencing risk for example is more of an issue for pre-retirees than for young accumulators. This may rule out a purely passive/indexed approach which puts them at the mercy of the markets, while longevity risk may also preclude a purely defensive approach for such a group. Understanding the characteristics of different client groups can thus give you a head start when looking to meet diverse client needs within a singular investment philosophy.
Young Professionals and Accumulation Phase
Young professionals typically have longer investment horizons and can tolerate higher levels of risk. Portfolios for this demographic would typically focus on growth-oriented investments.
Example:
• Client Profile: 40-year-old accumulator.
• Goal – To have $1mil in 20 years’ time (with no further additions).
• Current situation – $250k saved up.
• Investment need discussed and ascertained – approximately 7.5% p.a. returns over 20 years.
Considering that these clients require $1mil in 20 years, a quick reverse engineering process allows us to ascertain that investment returns (net of all fees) is approximately 7.57%. Under most risk profiles, this would likely fall in a growth/assertive/aggressive risk profile consisting of a higher allocation towards growth like assets (and less on defensive assets).
Pre-Retirees, Conservative Growth, Retirees, and Income Generation
Although retirement can last decades, sequencing risk means pre-retirees can have shorter investment horizons and a greater need for capital preservation. Their portfolios will typically have a balanced allocation, incorporating both growth-oriented investments and more conservative assets like bonds or income-generating securities. A conservative growth approach helps mitigate risk while providing potential for moderate returns.
Example:
• Client Profile: 65-year-old retiree.
• Goal – To draw 5% on a $1mil portfolio, living off $50k per annum (in line with pension drawdown rules).
• Investment need discussed and ascertained – to ensure that investment return is sufficient in balancing quality of life and longevity of funds. In this example, we can ascertain that sufficient risk should be taken in ensuring that, on average, 5% returns a year will mean that the client will continue to abide by the minimum pension drawdown rates, whilst living off an income that is sufficient for their retirement lives. However, in this instance, sequential risk can be explained to the client in ensuring that this is mitigated, and in the process, reinforcing the organisation’s investment philosophy of risk mitigation.
In both client scenarios, a pure passive/indexed approach may not be appropriate, either because it doesn’t offer enough upside scope, or enough downside protection. An investment philosophy therefore should not be dogmatically rigid, it should be flexible enough to reflect these divergent situations.
Conclusion
Constructing portfolios for different client demographics based on a consistent investment philosophy is a nuanced process that requires a deep understanding of clients’ unique characteristics, investment goals, and risk tolerance. By customizing portfolios according to demographics, while adhering to a consistent investment philosophy, financial advisors can help clients achieve their long-term financial objectives. A well-structured and tailored portfolio, combined with regular reviews and adjustments, can provide clients with the foundation for long-term wealth creation and financial security.
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