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Asset Allocation

Your clients’ plan should reflect their needs, goals, situation and risk tolerance.

By Janet Arrowood

Financial advisors often talk about the importance of asset allocation in financial planning, but do they follow through?

Do you talk to your clients about asset allocation, illustrate how it is done, invest your clients’ assets and then “let ’em ride”? If so, have you considered the fact that you might be gambling with your clients’ assets—and their future?

Asset allocation is often talked and written about, but more frequently than not, it is only partly implemented. If the asset-allocation approach is used, say as the result of a detailed factfinding and risk analysis, the next part—asset rebalancing—is also too often neglected.

Your clients’ investment and insurance choices need to reflect their needs, goals, life situations and risk tolerances. Circumstances, conditions and people change over time. For example:

  • Market conditions and investment climates change over time.
  • The top performing investments this year may be next year’s losers.
  • Risk tolerances and goals change over time.
  • Investment time horizons change.

Life happens. People retire, inherit money, change jobs, have babies, move to smaller houses and so on.

Defining asset allocation
Once you have done your factfinding and risk tolerance assessment, what are the key elements of asset allocation and risk tolerance assessment? What do you need to talk to your clients about?

Balancing risk and return
Balancing risk and return is an inherent part of factfinding. Asset allocation spreads investments across several types of asset classes, e.g., stocks, bonds, cash and real estate, to try to reduce risks.

Allocating assets
This is the next step. Many investment firms and mutual fund companies have model portfolios or funds that actually provide asset allocation based on your client’s risk profile. Ideally, the chosen asset classes should not be closely correlated. They should not all move in the same direction at the same time. If you want a detailed analysis of risk/return, do some research on Harry Markowitz and his “efficient frontier.” He won the Noble Prize for this work.

Revaluating once a year
Markets change. You should examine the performance of your clients’ investments, including assets in variable life, annuity products and retirement plans at least once a year. In volatile market conditions or rising interest rate climates, quarterly reviews are an excellent idea.

Rebalancing to maintain asset-allocation goals
Rebalancing takes time, but it also keeps you in touch with your clients. If the NASDAQ is rising and your client’s asset-allocation model calls for 30 percent growth and aggressive growth funds, he may find that his allocation has skewed. Now the allocation is at 43 percent, and the percentage of the more conservative elements has fallen.

It is time to lock in the gains and rebalance. Many mutual fund and money managers use automatic rebalancing. This can be on a continual, quarterly or similar basis. The key aspect is that this is done based on earlier agreements with the client and no direct contact is required to rebalance assets.

Reassessing risk tolerance
Times, situations, goals and needs change. Face-to-face reassessments are critical to ensure that yesterday’s asset allocation meets today’s (and tomorrow’s) needs and goals and risk tolerances.

Adjusting asset allocation
When things change, the asset-allocation model needs to change too. This may mean changing asset-allocation funds, manually reallocating assets or combining the two steps to ensure your client’s funds are properly allocated.

These steps are part of an ongoing process. As clients age, get promoted, have children or retire, the original asset allocation and the premises behind the allocation must be revisited. Then the assets must be rebalanced to maintain the desired asset-allocation percentages and accommodate the client’s risk tolerances while supporting his goals and needs.

Talking to clients about asset allocation is easy. Talking about rebalancing to maintain asset allocation is hard. No one wants to give up a winner, so they end up losing money in falling markets or failing to participate in rising ones. The result is that your client ends up on the losing end of many market cycles. He “buys high and sells low” and then blames you for the poor performance of his investments.

Avoiding the trap
To avoid this situation, you should first remember that your client invested with you in the first place because he trusted you and your judgment. He is counting on you to keep him on track and focused. He wants to hear from you, especially when markets are in flux.

Talk to your client about asset allocation and its relative—rebalancing. Show him the illustrations of a rebalanced and nonrebalanced portfolio over the past 10 or so years. Then get him into an auto-rebalancing program or make sure you manually rebalance his portfolio after each annual review.

By implementing a planned asset-allocation/rebalancing program for each client, you can often reduce their risk exposure and you will be forced to stay in touch with them. The closer you are to your clients, the less likely they are to go elsewhere for their financial needs.

Janet Arrowood is a Golden, Colo.-based freelance financial writer and trainer. She can be reached at thewritesource1@yahoo.com, or at 303-717-7444.

 


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