Most investors miss the most important concept in wealth management because they are laser focused on returns as the primary benchmark of success. This propensity to chase returns is magnified during periods when markets are shooting the lights out, as investors become acutely aware of how their portfolio is performing relative to whatever index is attracting the most attention at the time.
Under the emotional pressure of watching the markets rise, a nagging feeling starts to take hold of clients that drives a creeping dissatisfaction with their Advisor. During the tech bubble, it’s, “Why aren’t we keeping up with the Nasdaq?”. During the real estate bubble it was, “I can do way better than this flipping houses.” Now it’s, “Why don’t we load up on more dividend stocks?” Same refrain, different focus.
At times like this we like to spend a lot of time revisiting the core reasons that compelled our clients to hire an Advisor in the first place. For almost all of them, the core reason relates to their desire to reach one or more financial goals at some point in the future. Many are hoping to support children in university, and/or eventually retire with a comfortable lifestyle. Some clients are already drawing income from their portfolio, and are primarily concerned with ensuring that their portfolio doesn’t expire before they do.
Most investors imagine the wealth management process as a smooth ride from here to retirement. According to this illusory vision, investors unfailingly set aside exactly what they committed to put aside each year, and markets keeping up their end of the bargain by delivering the long-term average return year-in and year-out without exception. In reality of course, life sometimes gets in the way of savings, and the markets do NOT move in a straight line from A to B.
Fortunately, by examining the distribution of historical returns we can estimate the range of likely outcomes for portfolios around the long-term average return, or any other return estimate we wish to use. Once this range is known, we can determine the probability of a successful outcome – however we define success – within the range of possible outcomes. In this way, the wealth planning process becomes an exercise in risk management, but the risk is focused on the probability of reaching financial targets, rather than on the risk of short-term losses.
Along these lines, we try our best to keep our investors focused on these key tenets, which when taken together may represent the most important concept in wealth management:
1. Risk is measured as the probability that you won’t meet your financial goals.
2. Investing should have the exclusive objective of minimizing this risk.
Bill's Treasury Note 