Outcomes-based advice or broken dreams?

Financial planners lack the training and tools to effectively engage with clients. Daniel Miles and Halie Samson argue that current advice models should be thrown out and replaced with outcomes-based advice.

Financial advisers haven’t been properly armed with the tools they need to deliver quality advice. The limited education and modelling tools available are clunky and ineffective, forcing advisers to resort to spreadsheets and diagrams on whiteboards.

Risk profiling is at the heart of the advice process but risk profiling rarely incorporates a client’s capacity for risk with their financial needs. It has been reduced to a compliance exercise.

By getting clients to complete an online questionnaire, advisers can document a client’s risk tolerance, satisfy the “know your client” rule and circumvent a potential law suit in the future. However, risk profiling does not educate clients about the consequences of their actions or help them make more informed decisions.

Their answers may indicate the level of investment risk they can stomach but they don’t reveal the level of investment risk required to achieve their overall objectives.

Risk profiling surveys are also populated with irrelevant questions. For example, getting a client to rate their knowledge of financial markets is a redundant exercise because even those with a poor understanding may need to aggressively invest in growth assets to meet their objectives. Conversely, a client with a good knowledge of financial markets may be in a position to take a more conservative approach.

At the end of the process, clients are slotted into one of five or six static “growth/defensive” portfolios, which don’t factor in the real life stresses they could face such as a recession, inflation or a stock market shock. Almost all the risk embedded in these portfolios is equity market risk.

Challenged and improved

The entire advice process needs to be challenged and improved. Advisers must be armed with intelligent tools which spark more meaningful, productive client conversations. Client engagement and education tools should complement and integrate with these questionnaires to visually show clients the likely consequences of their actions and the risks they’ll be exposed to in the future. Portfolios must be built on these outputs to ensure clients achieve their goals but aren’t unnecessarily exposed to risks they have no capacity to absorb.

The alternative to risk profiling is outcomes-based advice. It’s a concept that’s being bandied around a lot at the moment yet few people really know what it means. It’s much more than simply discovering a client’s financial and lifestyle objectives then selecting investments that will maximise their chances of achieving those goals within a specific time frame.

With outcomes-based advice, a client’s current and future wealth and liabilities, and their investment approach, is considered in the context of their goals.

Portfolios are constructed and actively managed by professional asset consultants in line with a client’s goals not their risk profile. Portfolios are stress tested to see how underlying investments will perform under a myriad of market conditions as well as client-specific, real life situations. Investors are able to see the impact certain decisions, such as buying a new house or holding defensive investments, will have on their wealth and how long it will take for them to achieve their goals, if at all.

The reverse is also true. Outcomes-based advice shows clients exactly how much money they need, and the course of action that is required, to ensure they meet their goals within their desired time frame.

An adviser’s role

While the client discovery process has traditionally sought to uncover who the client is, how much they’re likely to earn over their working life and their risk tolerance, it hasn’t given due consideration to where they want to live, their ultimate goals, and the risks around those goals. It is an adviser’s role to help clients flesh out what’s really important to them, and prioritise those objectives.

It is also an adviser’s role to highlight any discrepancy between a client’s stated needs and objectives, and actual needs and objectives.

Outcomes-based advice attempts to foresee and understand a client’s future liabilities, and immunise portfolios against such liabilities. Investment products and strategies are only considered after a client understands what they want and how they can get there.

It all sounds completely logical and yet it’s a client’s risk profile, not their financial needs and objectives, which currently determines their asset allocation.

Even before a new or potential client has come into the office, the advice model has boxed them into one of six pre-mixed and fairly stagnant portfolios. This model was developed, in part, because financial planners historically didn’t have the skills or resources to construct portfolios. They also didn’t have access to professional asset consultants who operated in the wholesale and institutional realm. But times have changed.

Financial advisers are increasingly engaging professional asset consultants to help with portfolio construction.

Professional asset consultants will play a more significant role in the advice process, as more investors and advisers recognise the shortcomings of current advice-related tools and opt for outcomes-based advice.