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2017 FactRight Due Diligence Conference!

Why Risk Mitigation is Key to an Effective Investment Strategy

by Scott Smith

Risk Mitigation

Risk and its relation to the client's life should always be considered when making investment recommendations. As we’ve noted in past blog posts, risk management is something that shouldn’t be an afterthought to an investment strategy. Address risk up front when defining a client’s goals and objectives. It’s crucial to integrate a risk analysis into the portfolio-planning stage, not after the fact.  

Visualize a risk-strategy as the three points of a triangle. The two base points form the foundation, between the portfolio and the advisor. The portfolio and the advisor securely support the client on the top point, as the most important. Then, connect the dots. Risk stays inside the triangle. The agreed-upon boundaries regarding investment decisions will help you and your client keep risk in check. However, it is always the best practice to periodically revisit the client’s risk-management strategy to keep it up to date.

The Client

Financial advisors already know to consider where the client is in his or her life. The general rule is to pursue riskier investments when a client is further away from retirement or in some way, better suited to take on more risk, and to minimize it when a client is closer to retirement. 

In many situations, you’ll have to make judgments and recommendations based on your client's personality too. You need to consider how comfortable the client seems with various levels and kinds of risk. Many of the conclusions you draw will be based on an individual client’s life and what is going on in the big picture. The most important thing for clients to understand is that in all likelihood, the best-performing assets are also the riskiest. Advisors will need to determine whether the size of the investment exposes the client to a risk he or she is able to absorb and prepared to accept. 

Being aware of a client’s individual mission, his or her vision for life in the long-term and the short-term is key. Ask what the client’s values and goals are. Advisors who more easily connect with their clients are in turn more trusted by their clients. Clients feel like their advisors “get” them and what they are about. This can be even more true with younger clients.  

Although younger clients want to engage with you online rather than in a series of in-person meetings, they still want to feel a connection to you. If you create the right tools for them to do so, you are making their lives easier. If you make it easy for them to work with you on their terms, they will engage with you because it means you care about their needs.  

When you pay attention to your clients’ priorities and help them engage with you in a meaningful way that saves them time, money and energy, you’re managing risk for both of you. Happy, engaged and involved clients are less likely to feel that they didn’t understand the investment risks and are less likely to create legal problems for you. 

The Portfolio

Advisors can help clients generate income, achieve growth and maximize returns while appropriately managing risk by including alternative investments. are generally uncorrelated to the public markets. 

Alternatives include private notes, peer-to-peer lending, US and international real estate ventures and private placements. They also provide better diversification for risk management purposes because they can improve the risk/reward ratio.  

Diversification is the best way to manage risk, but how you diversify is key. Returns will vary among, and within asset classes, to hopefully balance out the risk of loss in principal value or from an underperforming gain. 

Also, consider investing in the sub-sectors within each asset class that have historically done well. For example, in the tech market, look at various types of technology companies to see who the biggest winners are and what the trends show. Look beyond domestic markets and keep several different investments in your portfolio to mitigate any company-specific risk. 

Be vigilant and continuously assess the performance and the quality of a client’s investments. Monitoring results at agreed-upon intervals assists in mitigating risk. You can get rid of underperforming assets and seize new opportunities as they happen more often if you do so. 

Realize that short-term, casino-like winnings are better left to high rollers in Las Vegas. Work within long-term frameworks to measure and achieve success. The market is always smarter than any advisor or any client. Most advisors can’t play the short game without being incredibly lucky or having insider information. And, neither counting on good luck, nor trading on insider information is something any advisor should be doing. 

Long-term investment strategies that contain diversified and alternative assets smooth out short-term volatility, minimize risk and take advantage of compound growth opportunities. That being said, having a long-term strategy does not mean failing to monitor assets over that same term. We recommend just the opposite. Ignoring a portfolio and maintaining the status-quo, willingly or not, is akin to a breach of your fiduciary duty to your clients. And that puts you both at great risk, financially and otherwise. 

The Advisor

Be knowledgeable about the products you recommend and always try to keep a step ahead of the marketplace. Anticipate demand for the kind of services and financial products your clients will demand. The alternatives market gains momentum each month as investors grow hungry for better returns at risk levels equal to the equity and bond markets. By sticking with a niche area, you can provide specialized solutions for markets that you know and understand very well. 

An advisor undertakes effective risk management by strategically balancing the client’s needs with a personally-matched group of assets that will likely include alternative investments. 

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