C.A.F.
February 18, 2019·3 comments·In Brief
Financial advisors are trained to optimize for returns and risk. But there's a hidden variable they're not taught to account for: whether clients will actually stay invested in what you recommend. The gap between what's best on paper and what clients will tolerate is where most wealth management actually fails.
• Sophisticated portfolios are failing even when they work. Risk parity strategies, diversification frameworks, and complex asset allocation decisions consistently lose client trust. Major firms have quietly renamed their most carefully constructed products because advisors couldn't sell them, even when they wanted to.
• Education doesn't fix the problem, it amplifies it. Transparency about holdings, trading rationale, and calculations didn't convert skeptical clients. Instead, detailed explanations came across as condescending. The client rejection happened regardless of how logically sound the strategy was.
• The core conflict is unsolvable through technique alone. A client leaving a portfolio does more damage long-term than compromising on portfolio construction. But advisors have no framework for knowing when to push and when to bend without sacrificing their professional judgment.
• The decision becomes about client lifestyle, not asset classes. What matters before building a portfolio is understanding how much downside a client can psychologically handle, what their actual life goals are, and whether they have realistic expectations about volatility. These aren't portfolio problems, they're planning problems.
• Without explicit rules, advisors default to what clients want rather than what clients need. The profession lacks a clear standard for where to take a hard stand on fees and independence versus where to show flexibility on strategy. This leaves the most difficult part of the job completely unguided.
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Comments
I love this note. I think this speaks directly to some tailwinds driving the popularity of cap-weighted index funds. These products are easy for clients to understand. Cheap. Tax-efficient. Perhaps most importantly (to borrow this framework), the speakers always sound the way the client expects them to sound. Tracking error is hugely problematic for many clients and the less “familiar” the strategy (ahem alts) the more problematic “unexpected” results become for the FA/client relationship and indeed the client’s commitment to the plan. As usual there is no Answer for this but this is a heckuva good suggestion for a Process.
If you can’t help a client overcome his/her own particular behavioral vulnerabilities, it doesn’t matter how much alpha you can generate. In my experience, this is mostly achieved through the planning or pre-investment part of the process. Making sure the client doesn’t have too much of their net worth on the table when risk is expensive. Making sure that the client understands how much downside they can handle before it starts to impact their lifestyle & goals. Getting clear and rational about the real world objectives for the wealth we hope to create so that we can focus on outcomes rather than purely on relative returns. These are better starting places for addressing the CAF issue than portfolio construction.
Hi Rusty,
Just joined ET today. I was drawn in by the home entertainment dilemma you posed. I was getting ready to share what I think is a really good trade-off on cost, quality of sound, size and aesthetics. My mistake! Thanks for the advise to follow my own advise. Honestly, I have found that hard to do as the desire to optimize combined with fear of “what worked before (backtest) won’t work going forward”. The good news is that I am getting better at following my own advise as time goes by. Some people call that discipline, I think there is experience/wisdom in the mix.
Happy wintering:)
Tom
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