The beginning of the year is an opportune time to review the investments our clients own and those we recommend and have recommended.
The Reason For Purchasing a Security
It is always good practice to identify the reason why we are recommending or purchasing a given security
. We may know at the time of purchase, but if we don’t write it down we may not remember it. This can make it difficult to assess whether a security is still worth owning since its initial purpose is forgotten.Generally, we recommend specific investments for diversification purposes
and to develop a portfolio commensurate with the client’s risk and return objectives. But with so many investment options, we also need to ensure that the specific security is a better one than an alternate.
For instance, if we need to own 15% in international investments, why are we choosing one active fund over another? And why are we recommending the client pay more for an active manager than a low index fund?Is it because the wholesaler made a great presentation or financially supports our business? (Few may admit to this, but let’s admit we all know advisors that are consciously or unconsciously influenced by it
). Is it because said active manager does things differently than index funds, and therefore offers value to the portfolio? Is it because past performance is solid, and we are extrapolating past performance to the future?Whether we are a fiduciary or not, it is good practice to identify the reason for every recommendation and ensure they are in the client’s best interest
and not just suitable (and in our own best interest).
The Reason For Holding a Security
That brings us to today. As we look over client portfolios, why are we holding the securities we do? Status quo makes them easy to hold, and the error of commission looms larger than the error of omission.
We should ask ourselves the same questions when holding a security as we do at time of recommendation. The reality is we may have purchased them due to prior biases or misinformation we weren’t privy to. Maybe we felt that a star manager would replicate past performance. Maybe we just made an unwise recommendation,
regardless of the reason. No one is perfect and we are all learning (and I hope progressing). The purpose of doing an internal review of your recommendations is not to defend your prior decision(s)
. A really good internal review should challenge you to identify why you continue to recommend each position. Play devil’s advocate. The reality is, maybe there is something better, lower cost, more diversified etc… In that case, it may be wise to select a replacement that is more in line with client goals, risks and desired cost.Related: 3 Perspectives on Volatility to Share With Clients
A Fiduciary Needs to Overcome Biases
Behavioral biases are real! They influence everyone (yes, even you). If you don’t think so, then you are overconfident. These biases are often unconscious and can lead us to give unwise advice.
Most advisors really care about their clients and will do anything for them. But sometimes we give advice that is poor and/or not in the client’s best interest simply due to these unconscious biases. So, it’s not really our fault. But the truth is, it still is. It is up to us to learn how we think, feel and how mental shortcuts and emotions can influence our recommendations.A thought exercise and thorough analysis as I mention above will not be easy. It may open your eyes to suboptimal advice you have given in the past. That’s OK. Just make the change moving forward – that is the concept of progression and improvement. As you do this exercise, it will negate the biases by bringing decision making to the cognitive brain.
And it will help you gain greater confidence and conviction in the investments that you recommend…conviction that not only are these suitable, but they are also in the client’s best interest