January 16, 2012
What is the proof that you have given “The Right Advice”?
Sadique Neelgund
What is clear from both recent regulatory reforms and best practice discussions is that the client’s informed consent to the risk in their financial plan is of critical importance. Over the years we have worked with advisers in many jurisdictions and have developed an overview of the planning process that sits logically above local regulatory obligation. At its core is a process to help clients make an informed decision.
Financial Planners can serve their clients while protecting themselves by rigorously seeking to develop & apply five proofs to their client advisory process as follows:
1. Planners can prove with know-your-client: current situation (assets and liabilities), present and future cash flows, aspirations, risk tolerance and risk capacity. Best practice tells us that advisors should be able to illustrate this to clients with words, numbers and pictures. For instance, the client might need to decide if they will take the investment risk required to meet their goal of leaving an estate to their children of approximately $200,000 at age 96 or run out of money at age 86 by accepting the investment risk consistent with their risk tolerance.
2. Planners can prove that they have explored the range of alternative plans and strategies with the client. These strategies may include converting lifestyle assets to investment assets such as downsizing the family home, a need to work longer and harder, spend differently, change jobs or perhaps set up a business. The overall goal is to improve the client’s lifetime cash flow position. Good planning software will allow multiple what-if scenarios to be explored, storing the results of each exploration.
3. Planners can prove with ‘know-the-product’ for the products that they have selected to implement the client’s strategy. Once they have decided on the strategy and relevant products they need to understand those products so they can argue that they appropriately meet the client’s needs. They may use external research to make those decisions but the advisor is responsible for the final recommendation. The key issue, revealed by the 2008 global melt down, is to understand how the product or service will behave when the markets fail. Many products work well in good times but have a history of failing in bad times. A good understanding of economic history is needed when stress-testing products.
4. Planners can prove that they have explained the risks in the strategy and in the products, particularly to establish performance and down side expectations. The advisor can then determine with the client the level of financial risk that the client is prepared to accept in pursuit of goals. Generally risk is translated through to the amount and type of risky assets such as shares and property held compared to safe assets such as cash in the bank. Some may choose to hold more non-risky assets even though they might have less chance of achieving their future goals. Critical here is both an education of the client – illustrating what can be lost – and an understanding by the client of the impact on their plans if that loss occurs.
5. Planners can prove that they received the client’s informed consent to accept those risks in pursuit of their goals. As well as illustrating the more probable outcomes they need to explore the worst case scenarios. They must be able to illustrate extreme events and explore clients’ risk capacities. They must be able to show the consistency of the financial plan with the client’s risk tolerance. They must have established processes for setting performance expectations and for ongoing management.
Obtaining the client’s informed consent is an ongoing responsibility. This lies at the heart of the value of the relationship, but is not always understood by advisors or clients. Ongoing informed consent is about ensuring that the advisor continues to understand not just the client’s risk tolerance – which is relatively stable – but risk perception, which can change in a heartbeat, and risk required, which can change in time, and risk capacity, which also varies over time.
Financial advisory businesses the world over are facing unprecedented challenges, not the least of which relate to improved suitability practices.
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Paul, excellent article and insightful , lots of food for thought for all practising planners
Dear Mr Paul,
Thanks for valuable insights. Today and tomorrow’s financial planners have to adopt a totally different approach in dealing with their clients. The points you mentioned are I think are very fundamental in nature in a planner-client relationship. When more is expected of this relationship, they would definitely stand in the good stead.
Regards,
Narendra N Kondajji
Narendra, financial planning where the clients takes some responsibility for the investment decision is the only logical and sensible way to proceed. The excesses of a free market that are consistent with the notion of caveat emptor are no longer acceptable practices, on the other hand we need to be very cautious of the creeping paternalism that seeks to protect customers. The middle ground is seeking our clients informed consent. Transparency and literacy are the key inputs.
Very good article.
Thank you. I appreciate your approbation.
Uttam Kumar Sen on Facebook Page
thanks….can you provide something in India “Psychometric Standards for Risk Tolerance Testing” kind of software so that we can use?
Sadique, I am working on it. Will let you know shortly.
Dear Paul,
I am using Finametrica from last 7 months – I am very satisfied with the overall process & outcome. 🙂
Thanks Hemant, it’s always good to receive positive feedback. You might be interested to know that other than words of recommendation it is the annual renewal rate that confirms our subscriber satisfaction. Since we commenced commercial activity in 1998 more than 80% of existing customers have renewed each year.
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