Gearing advice to specific financial goals is a powerful way to demonstrate added value and increase client engagement. But this requires careful thought about advice monitoring, efficiency and - of course - compliance, explains Ronald Janssen, Solution Owner, Goal-Based Planning, at Ortec Finance.

The industry’s efforts to automate (parts of) the advice process are progressing fast, driven largely by technological advances and the increased availability of digital data. Yet, as ever, achieving progress is not without its challenges. 

Chief among them is how to maintain regulatory compliance when advice is generated by an algorithm. Then, there are all the considerations about engaging with clients efficiently and constructing an optimal hybrid journey that allows both clients and advisors to work together in the best way. Just as important, though perhaps not as easily appreciated, is the need to monitor advice in an efficient manner. This will ensure that added value is demonstrably delivered. 

Regulators’ focus on the suitability of advice continues to get tighter globally, creating a concomitant need to monitor the advice clients are being given with real rigor. As we all know, firms must ensure that their advice aligns with a client’s willingness and ability to assume investment risk (or to put it more starkly, their capacity to bear losses). And, in recognition that people generally invest for a reason related to life plans, we must be able to demonstrate that the risks taken really are necessary to achieve those personal goals.

Risk exposure thrown into stark relief     
The dramatic market downturns and uncertainty caused by the coronavirus pandemic threw this last imperative into stark relief. In many cases, the risk that a client is willing to take is determined with a questionnaire, a qualitative approach. This gives no answer to the question: is it realistic that the client can achieve his or her personal goal? In some instances, the client may need to take more risk with (parts of) their investment portfolio, while in others the client can afford to take less risk to achieve their personal goals. With a goal-based approach, the client gains insight into the short-term risk of the portfolio, but also its long-term risk, their capacity to take risk and the probability of achieving a goal. These insights help answer why a client should take more or less risk.

Why would you advise a client to take on more risk than actually necessary? Even though the question may seem rhetorical, it is not common practice to check whether the risk level of a client’s portfolio actually fits with the risk level necessary to achieve the personal goal. Because most portfolio decisions are still mainly driven by the outcome of a generic risk questionnaire, the connection between this decision, the client’s financial situation, the goal and the remaining horizon is often absent. 

Advisors can add more value to the client    
As time progresses, the value of a portfolio will fluctuate, based on the performance of the markets and client deposits and withdrawals. Over time, there may be opportunities to reduce the risk of the portfolio due to better-than-expected results and possibly because of a shorter investment horizon. As markets showed last year, the timely mitigation of the downside of a portfolio may be hugely beneficial to both client and advisor. In contrast, during the investment horizon there may also be need for adjustments to the plan, when performance disappoints. Proactive suggestions, e.g. to make extra deposits or to take extra risk (if the client is willing and able), and timely course corrections clearly prove the added value of the advisor to the client, so why isn’t this common practice yet? 

Need for realistic portfolio projections
In order to monitor client goals proactively, advisors need to have insights into realistic and up-to-date projections of the client’s portfolio. Realistic projections require a more sophisticated approach than simply looking at the past performance of the portfolio. In our white paper A goal-based plan deserves more than a standard “Monte Carlo”, we explain that in order to provide good quality portfolio projections, the current market practice of simple “Monte Carlo” simulations is not sufficient to generate insights into the probability of success in attaining client goals. Providing up-to-date and realistic insights as to whether a portfolio is likely to reach its objective is not easy, but a solution exists. With Ortec Finance’s monthly updated economic outlook and the operational capacity to evaluate hundreds of thousands of portfolios overnight, wealth management firms can start bringing this additional value to their advisors, portfolio managers and clients. 

Proving the added value of goal monitoring   
Theoretically, the idea of proactively reducing the amount of risk in the portfolio after better-than-expected results and/or a shorter investment horizon sounds appealing. The question is whether this idea also holds in practice. 

For us, this is a resounding “yes”. We have back-tested this methodology based on our back-dated economic outlook until the year 2000. Specifically, we compare a static portfolio decision with a dynamic approach, which re-evaluates the portfolio decision every year, based on the updated projection of the portfolio, given the actual realization on the markets. The decision rule is based on the principle that the advisor adjusts the risk of the portfolio to the minimum amount possible, given the risk appetite and ambition of the goal. We find that for multiple use cases, historical windows, goal ambition and initial risk levels, our dynamic strategy leads to better outcomes for the client.

In every case, the dynamic strategy leads either to a higher value portfolio at the end of the investment horizon or achieves the goal with less exposure to market downturns. As such, we have definitively proven that a dynamic lifecycle approach delivers added value over a static lifecycle approach. Read our white paper, Enable goal-based planning and monitoring for 100% of your clients for more background information. 

The technology is there, why wait? 
Recent turbulence of the financial markets and the current uncertainty about the global economy highlight the necessity for frequently updated plans and goal-based strategies. The prevailing practice of providing a static plan and generic questionnaire to help clients reach their financial objectives, based on past performance only, is outdated. During challenging times, the need for changing the way we operate becomes very clear. The technology is available to empower your advisors to deliver demonstrable added value and to improve the investment decision-making of 10 per cent of your client base – and all while reaping the rewards of immaculate compliance and greater operational efficiency too. With goal-based advice, we have shown how easily great ideas can be translated into great practice. Why wait?

For more information visit: www.ortecfinance.com/OPAL

This is a chapter from the 2021 edition of Technology Traps Wealth Managers Must Avoid. Click here to download your free copy.