ELITE ADVISOR BEST PRACTICES

Investment Philosophy

Four keys to effective asset management

By Guy Baker

Key Takeaways:

  • Our convictions protect clients from making poor choices during tough times.
  • A strong, values-based philosophy allows advisors and their clients to withstand the temptations brought by indecision and fear.
  • There are four key areas in which our investment philosophy contributes to effective asset management: risk, diversification, expenses and rebalancing.


In the final analysis, the only thing that has staying power is values-based convictions. Values-based convictions are determined by experience and character, both of which are hard-earned and worth the intense battle that is often waged to win them. These traits become the core of our philosophy. These traits provide the fruit of our labor. But most important, it is our convictions that protect clients from making poor choices during tough times. Without a philosophy, we are buffeted by the winds of indecision and change. But if we have a strong, values-based philosophy, we are able to apply it and withstand the temptations brought by indecision and fear.

Philosophy is integral to every part of our life. Whether it is relationships, investments, budgeting and spending, employment, education, health or service (this is not a complete list), philosophy matters. Philosophy dictates our actions and our attitude.

4 keys to an effective asset management

There are four key areas in which philosophy is particularly important to asset management: our attitudes toward risk, diversification, expenses and fees, and rebalancing. Let’s look at each one quickly and see why philosophy trumps logic.

1. Risk – In order to develop a philosophy about risk, you first need to define it. What is risk? How much risk are you willing to take? What does risk cost? What are ways in which you can avoid risk? How can you profit from risk? These are all important questions that center around your understanding of and ability to communicate risk to your clients and their advisors. Experienced advisors know that markets go up and markets go down. So, do you bail every time the market does what it does? Research from Dimensional Fund Advisors shows that 99 percent of market returns during the last 85 years are attributable to just 35 months. How do you communicate this to clients? You have to have a philosophy about risk and communicate it with strength and conviction. Otherwise, you will be whipsawed along with your client’s portfolio.

2. Diversification – There are two forms of diversification: efficient and inefficient. A strong philosophy helps the advisor to understand the difference and to build portfolios that are properly diversified. How do you avoid style drift? How do you build a portfolio that can be correlated to the unique market movements integral to international and domestic markets? What about markets within the markets? How do you properly allocate to take advantage of the growth value paradigm?

3. Costs – How do you set your fees? What value do you bring, and how do show that your value is worth the fee you charge? What about the expenses within your portfolio? The asset management fees, the trading costs, the impact of taxes? Are you an advocate of active or passive management? Why did you choose your philosophy? Total cost can be 40 to 50 percent of historical returns. What is your philosophy toward costs and the impact this has on your clients’ long-term results?

4. Rebalancing –Is this important? Why is it important? How often do you rebalance? How do you explain the impact this has on taxes and fees? How do you justify the value? According to Dimensional Fund Advisors, research has shown that rebalancing can be very beneficial if the cost is not disproportional. What is your philosophy on rebalancing — and how do you explain your approach and the value?

Conclusion

These are just four of the important investment issues we deal with regularly. Shouldn’t you have a clear and concise philosophy on how you do this and why? The more time you spend thinking strategically and developing a clear-cut approach, the more confidence you will have in your services. But more important, the more confidence you will engender with your clients. Spend the time thinking through these issues. They will make you a better advisor.


About the Author

Guy Baker, MBA, MSFS, CFP® is a financial advisor to business owners. He works to help owners find ways to reorganize their planning to achieve tax-efficient solutions to their succession, retirement and estate planning problems. Guy is a 34-year member of Top of the Table and recognized by Worth magazine as one of the top 250 financial advisors. For more information, you can contact him at guy@bmiconsulting.com or through www.bmiconsulting.com.