We’re a week into the New Year.  The first moment of truth of New Year’s resolutions.

But rather than actual goals, let’s create a hypothetical resolution.  Let’s say your goal was, “I am going to lose weight this year”.  Fair enough, albeit a bit ambiguous in its conception.  You didn’t state, “How much weight am I going to lose?”, “How long is it going to take me to lose the weight?”, “What is the plan to lose the weight?” “Diet?” “Exercise?”  You didn’t choose the type of diet, type of exercise.  “Will it be a combination?” And perhaps most importantly, “Who will hold me accountable?”

Clearly you will need help.  You call one of the many weight loss programs, set up an appointment for next week and feel good thinking you’ve taken concrete action to execute on a New Year’s resolution.

But you realize something.  Part of the problem of why weight is an issue in the first place, is you are a terrible cook.  And by terrible, you mean REALLY TERRIBLE.  Like, the animals in your neighborhood boycott your garbage because the leftovers are inedible.  To a stray cat!  Due to this complete ineptitude with culinary prowess, you eat out a lot.  Or you order in a lot.  Or you buy a lot of pre- cooked meals.  While the neighborhood felines appreciate these nights, none of these eating habits help with weight loss, as none of these meals are designed to mitigate your calorie intact.

So you take further action.  You hire a personal chef to teach you how to cook.  The chef is available tomorrow night.  She arrives at your house and teaches you how to make unimaginable delicacies.  Lasagna, steak au poivre, fish n chips, and risotto.  She’s a wizard at simplifying complexity so even your ineptitude is conquered, and you master these recipes.

One minor hiccup, you visited the doctor last week and found out you should avoid cooking oils for your cholesterol issues.  The chef recommends you “alternate” coconut oil and you’re in business.

Next week comes, and you have your appointment with the weight loss clinic.  You decide with your mentor to target 25 lbs as your weight loss target and set 4 months as your time frame.  You aim for a 1,700 calorie per day intake.  That, coupled with a 3-4 day per week exercise regimen, should create a weekly calorie deficit of approx. 1,200 calories per week and that should have you hitting your goal.

You go home.  Excited with your plan and motivated to begin your new, healthy life.  You decide to use your new cooking skills and make… lasagna.  The next night you make risotto, followed by fish n chips and for the weekend treat, steak au poivre.

In four months, you’ve gained 15 lbs.

What my hypothetical -quite bluntly- illustrates, is exactly how we, in the Wealth Management industry, combine portfolio construction with a Financial Plan.  Clearly in my inelegant and transparent metaphor, the chef is the portfolio construction, and the weight loss program is the financial plan.

We visited the chef first and started cooking our meals with absolutely no regard to what we’re trying to accomplish.  So the goal becomes having the best tasting meals possible.  Regardless of the number of calories or what the implications might be down the road.  Exactly like, chasing after the highest returns regardless of whether they aligned with your targeted financial goals or whether you even had a need for the additional portfolio value that you may (or equally as likely) may not have gotten.

To be fair we did visit the doctor and get a health check on saturated fats which we substituted for coconut oil.  But coconut oil has the same caloric properties as most other cooking oils, they just don’t clog our arteries the same way.  In other words, we did a Risk Tolerance Questionnaire, which told us how we might feel about risk, but tells us nothing with regards to reaching our targets.

Then after the meal plan was decided, we met with the weight loss consultant who created the plan.  We never compared notes.  We never analyzed whether those meals gave us a shot at our targeted calorie intact.  We simply stated, “this is how much weight I want to lose” on one hand, and then said, “and this is what I’m going eat,” on the other.

No one would create a weight loss program in this way.  Never in this order.  Certainly not without detailing what foods needed to be consumed to reach your goals.

So why do we continue to do this as financial planners?

Or worse, why do we pretend we don’t?  On any given year, I interact with well over 100 individual practices.  Almost without exception, I visit their website and their stated process goes something like:

  1. Ascertain your goals.
  2. Detailed analysis of your current holdings and financial situation.
  3. Present comprehensive plan.
  4. Execute on portfolio.

Then when I dig in and find out what actually takes place it looks something like:

  1. Review current portfolio
  2. Recommend new portfolio
  3. Perform Risk Tolerance Questionnaire
  4. Execute on portfolio
  5. Create financial plan (if an actual plan is created)

Then worst of all, complain that the clients only evaluate you based on your portfolio performance.

This is NOT the way to do it.  Particularly, when we know from study after study, that what our clients ask of us is to provide ‘holistic’ advice.  Creating a financial plan after the portfolio has been constructed is not ‘holistic’ advice.  It’s the creation of a staid document that becomes obsolete at the exact moment of its creation.

A properly constructed financial plan should provide the guard rails for the ultimate portfolio. It should highlight the targeted returns needed for a client to reach their stated goals. However, every bit as important is understanding the amount of allowable volatility (standard deviation) that a portfolio can absorb.  Then finally, you must have some ongoing measuring stick to ascertain whether those targets are being met and whether the financial plan remains viable and on tract.

In other words, if you’ve created a financial plan with an expected rate of return of 5%, and you delivered a -12% return that year, you need to have decided how to tell your client whether there is an issue or not?  I can promise you the answer is not to say, “Well the market as a whole is down 25% and you’re only down 12%, so you should feel good.”

Not if the benchmark you’ve created for this client was only down 5%.  Not if the allowable volatility on the plan is -5%.  Stated plainly, not if it isn’t consistent with the metrics you’ve agreed upon in the Financial Plan.  Before you created the portfolio!

I will address these metrics in the next blog, but for now, let’s just agree, creating a portfolio without knowing the calories is a recipe for disaster.  (see what I did there!)

Clive Cholerton
Executive Partner
QWealth Partners