Growing up in a sailing family, the first thing I learned was that the wind was both an ally and an adversary.
Having the wind at your back is a comfortable and expeditious way to get from point A to point B. But sometimes you encounter a headwind. This point of sail is referred to as beating into the wind, and it’s every bit as uncomfortable as it sounds.
To some clients — particularly those who need to make sizable investments in or change their asset allocations to stocks, rollover a 401(k) or invest the proceeds from the sale of a business — this may seem an apt analogy for investing today’s market environment with equity indexes nearing all-time highs. Clients may struggle with the timing of investing large tranches of their wealth, and their fear of regret may result in inaction. After all, if they don’t invest they can’t regret it, right?
Resolving this tricky impasse for a client often increases the odds of investment success, which clearly represents a value-added service by the advisor. But how?
While no one possesses the ability to help clients make perfect choices, there is an effective way to deal with this behavioral coaching challenge: An equity investment plan . Unlike a dollar-cost-averaging strategy, an EIP focuses on the investor’s strategic asset allocation, and typically includes three basic steps:
1. Determine the client’s appropriate strategic asset allocation.
2. Calculate the difference between the current allocation to stocks in the client’s portfolio and the target strategic asset allocation.
3. Divide the difference into parts: an immediate investment to get things moving and a subsequent set of target equity weightings to be attained by specific dates.
While it is typically better in the long run to invest the full strategic allocation to stocks immediately in view of an expected long-term equity risk premium, investor reservations should not necessarily be ignored. Feeling heard and understood is an important factor that contributes to higher trust between financial advisor and client.
An EIP strategy is not the principal way to manage the portfolio, but rather an attempt to manage the client’s behavior. Client behavior and discipline are critical factors in achieving their long-term investment success.
The EIP process helps advisors disconnect their clients from emotions created by market swings by absolving them from the timing of investment decisions. Instead, advisors can help their clients focus on bringing the portfolio’s stock allocations in line with specific weightings based on the specific schedule determined during the EIP process.
The frequency and duration of an EIP can be chosen to suit each investor’s circumstances. That said, we believe the overall period should not be too long. Two or three years, for example, could be excessive.
To systematically understand the families you work with, first get to know their views on key behavioral-finance criteria, writes Michael Liersch.
Importantly, the dollar value of each transaction will vary as the portfolio’s value changes in response to investment returns. For example, if the stock portion of the portfolio were to rise in value from one scheduled transaction to the next, then the dollar amount of the transaction would be less than if the stock value were to fall. In this way the EIP is adaptive to portfolio returns, unlike a dollar-cost-averaging strategy.
For clients, timing decisions may be an obstacle to their investment success. Whether in bull or bear markets, it may never seem to be the “right” time to buy stocks. An EIP helps separate the emotional aspect of investing in assets with risk from the pragmatic: Although risk is explicit with stocks, some exposure to them is necessary for most investors to pursue the higher returns required for their long-run needs.
To be successful in creating wealth for your clients, there are certainly other powerful tools at your disposal — increased savings rates, diversification and asset allocation. However, an EIP provides advisors with a strategy to help clients overcome emotional headwinds that can capsize an otherwise well-thought-out financial plan.
