Does your allocation model represent your clients’ goals?
Clients come to you for advice on how much to save, how much to spend and, most importantly, how they should invest given their spending and saving decisions. Investors have financial goals with long durations and unique circumstances—goals that deserve a thoughtful investment approach.
Given that one of the roles of an advisor is to help clients achieve long-term goals, it often surprises me how large a role mean variance optimization plays in some advisory firms, relative to lifecycle investing. Albeit, mean variance optimization is a pillar of modern finance: it identifies the portfolio that gives the highest expected return for the least amount of volatility. But most clients have much richer goals than simply finding the most return for the least amount of volatility.
Clients who are saving for retirement typically want to generate enough wealth to fund a desirable retirement. And, for those clients already in retirement, they usually want to have as high of a lifestyle as possible without running out of money before they die. As great as mean variance is, it’s not the right tool for solving multi-period concerns like these.
We believe lifecycle investing is a better way to help investors achieve their retirement goals. Most people are familiar with lifecycle investing through target date glide paths that alter the asset allocation of an investor as he or she progresses towards retirement. Importantly, lifecycle investing seeks to address the lifetime saving, spending, and investing considerations clients face, whereas the mean variance model does not.
Over the past decade quite a lot of thinking has gone into the lifecycle investment model. An important area that Russell has pushed forward is dynamic lifecycle investing that goes by the name of Adaptive Investing. While target date glide paths are predetermined paths through time, Adaptive Investing responds to the outcome the investor experiences. It provides a different asset allocation following 10 years of great market returns than it would if the market returns had been poor.
Why does it do this? The appropriate allocation depends on the investors’ account balance relative to the goals the account is to fund. And, of course, the account balance depends on market returns. Investors who have more than enough wealth saved for retirement need a different allocation strategy than investors that have not saved enough. Adaptive Investing tethers the goal and account balance to the best investment strategy given the predicament.
As you help your clients plan for retirement income, consider the investment model you employ. Mean variance optimization is an important tool to build efficient portfolios measured by mean return and volatility, but it’s not meant to address the much more macro problem of lifecycle investing. In comparison, Adaptive Investing focuses on outcomes, progress and strategy to try and best achieve goals reached over multiple investment periods.