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Use Needs Rather than Fear for Allocation

Published on September 21, 2017
Many advisors use risk tolerance to determine how to allocate client assets, putting clients in buckets of conservative, moderate or aggressive based on the question “How scared are you?” This approach can result in poor risk management, significant misallocation of resources and a high degree of anxiety. A better approach is to use a needs-based planning process to match resources to client goals.

NEEDS-BASED PLANNING MODEL

Source: AthenaInvest Advisors LLC

In the needs-based allocation approach, the goal is to optimize available resources. For example, you can use insurance solutions to mitigate catastrophic risk, set aside cash for liquidity and then allocate remaining capital to investments designed for income and long-term growth. The resulting answer is rarely 60% equities and 40% bonds. The needs-based approach helps to ensure specific short-terms needs are being met while allowing long-term investments to grow over time. Each year, or as events arise, the allocation can be adjusted for changing circumstances. This all leads to higher levels of confidence, control and comfort which reduces anxiety and allows investors and advisors to stay on track during challenging times.

From the Behavioral Viewpoint


What is Going On?

  1. Investors and advisors have a present bias, where they don’t consider the future enough and focus on the present instead. Thus, they over-allocate to short-term comfort at the expense of long-term wealth.
  2. Planning requires time, effort and discipline. The industry offers a simple solution in the form of suitability and risk tolerance. Advisors and investors substitute this for the real work of matching resources to needs.
  3. There is an availability and confirmation bias in the form of the widely available and heavily promoted risk tolerance questionnaires and risk-based portfolio solutions, accelerated and propagated by technology and regulators.  

What can we do?

  1. Develop a comprehensive needs-based financial plan that maps resources to goals.
  2. Utilize specialized solutions and expertise within each needs category.
  3. Measure progress towards established goals and revisit the plan regularly to reflect evolving circumstances and events.
  4. Work with a skilled advisor who can provide valuable education, perspective and coaching.

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IMPORTANT INFORMATION AND DISCLOSURES

The information provided here is for general informational purposes only and should not be considered an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  It should not be assumed that recommendations of AthenaInvest made herein or in the future will be profitable or will equal the past performance records of any AthenaInvest investment strategy or product.  There can be no assurance that future recommendations will achieve comparable results.  The author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions.  AthenaInvest disclaims any responsibility to update such views.  These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any AthenaInvest representative.

You are solely responsible for determining whether any investment, investment strategy, security, or related transaction is appropriate for you based on your personal investment objectives and financial circumstances.  You should consult with a qualified financial adviser, legal or tax professional regarding your specific situation.  Investments involve risk and unless otherwise stated, are not guaranteed. Past performance is not indicative of future performance.

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