Building a well-structured investment portfolio is crucial for achieving long-term financial success. However, different client demographics have unique investment goals, risk tolerances, and time horizons. To cater to these diverse needs, it is essential to construct portfolios that align with each client’s demographic characteristics while adhering to a consistent investment philosophy. In this article, we will explore the key considerations and strategies for constructing portfolios that meet the requirements of various client demographics, while maintaining a consistent investment philosophy. We will explore this using the following example – through the lens of some applicable investment principles (which forms a part of a sample investment philosophy).
Applicable Investment Principles
A) We do not have to get it right to benefit.
Out of a plausible set of scenarios that might pan out (say 10), we should ensure that we can benefit from the majority (e.g. 8). If we were to rinse and repeat that process for the long term, that is how wealth is generated and created.
B) Goals-based investing
We can first ascertain how much we need and at what point – e.g. if 6% gets the client where they need to be, then there is no need to take extra and sometimes unnecessary risk to chase that extra 1-2%. In portfolio construction, law of diminishing returns does kick in, especially in the upper end of the risk curve – to chase a smaller marginal return, we need to take that much more risk for the same risk profile band. In this respect, it is a reverse engineering process to ensure that the downside of chasing more returns (risk) is mitigated.
For retirees, we can ensure that the balance is struck between quality of life and longevity of funds. For example, a drawdown of $100k on a $500k portfolio might mean that a retiree client has a great 5-7 years, but longevity of funds is threatened at this rate of drawdown relative to the size of the portfolio.
C) Long-Term Focus.
Advisors generally understand the long term nature of investments, however, it is important to articulate this to clients. Main benefits include the reduction in short term market volatility and utilising the compounding effect of returns.
D) Manage risk.
Risk Management Strategies
Implement risk management strategies that align with the client’s risk profile and investment philosophy. These strategies aim to control downside risk and limit potential losses, and controlling the risk of a portfolio can be prudent as most times, this might be one aspect that can be controlled (unsystematic risk). Here are a few commonly used risk management techniques:
a) Diversification
Diversifying across different asset classes, sectors, and geographic regions can help mitigate risk. By spreading investments, you reduce the impact of any single investment’s poor performance on the overall portfolio.
b) Asset Class Selection
Choosing specific assets within each asset class can further manage risk. For example, within equities, selecting a mix of large-cap and small-cap stocks or diversifying across industries can help reduce concentration risk.
c) Portfolio Rebalancing
Regularly review and rebalance portfolios to maintain the desired asset allocation. Rebalancing involves selling overperforming assets and buying underperforming assets to bring the portfolio back to its target allocation. This practice ensures that risk exposure remains in line with the client’s risk profile.
d) Risk-Adjusted Returns
Consider risk-adjusted returns when evaluating investments. Metrics like the Sharpe ratio or the Sortino ratio help assess the return earned relative to the amount of risk taken. Investments with higher risk-adjusted returns may be more suitable for clients with higher risk profiles.
e) Ensure that sequential risk is mitigated
One very important risk that can be managed within investments portfolio is ensuring that any drawdowns should be derived from the defensive side of the portfolio. Controlling the part of the portfolio that withdrawals come from can mitigate sequential risk (e.g. a $100 portfolio with a 20% fall =25% recovery back to $100 vs a 10% fall which requires only 11.67% to recover back to $100).
Understanding Client Demographics
Before constructing a portfolio, it is crucial to understand the unique characteristics of different client demographics. Demographics can include factors such as age, income, risk tolerance, investment goals, and time horizons. By assessing these variables, financial advisors can tailor portfolios to meet specific client needs.
Young Professionals and Accumulation Phase
Young professionals typically have longer investment horizons and can tolerate higher levels of risk. Portfolios for this demographic should focus on growth-oriented investments such as stocks and equity funds.
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
Pre-retirees have shorter investment horizons and a greater need for capital preservation. Their portfolios should 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.
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. Lastly, there are numerous advisors on Ensombl that service different clienteles. A great first step would be researching and finding the different methods that advisors adopt, and then tailor it to your own clients/clientele.
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