Letter To A Friend. {Part I}

I had drinks with a friend a few weeks ago.  He asked me some questions on picking advisors and we had a bit of a debate on the concept of risk.  What is following over the next several days is my response to him.  Since I spent some time working on this I thought I would share it with you as well.

Dear XXXXX:

I thought this would be the best way for me to answer some of the basic questions you asked me when we went out. Here I’ll address how when given multiple advisors can you tell which one has performed the best and the concept of risk as I see it.

When judging advisors, most investors simply compare returns. Asset manager A, who returned 10% last year, will in this example beat out manager B who returned 6% in the same period. The problem with this approach is that it usually ignores an investor’s risk and return objectives. When comparing how different advisors or mutual funds etc have done, the first thing you need to know is how they have done based on your own unique investment criteria and goals.

Understanding a client’s goals usually comes about by formulating an investment plan. I think of this as different from a financial plan. A financial plan is a blueprint that should take into account much of a client’s financial landscape. This should include among other things, income projections, estate planning, insurance needs as well as retirement planning and investments.

I believe that an investment plan should at least answer the following questions: What are my risk/return criteria? How will my portfolio be constructed based on my criteria? What is my plan for when things go wrong? The investment plan is a baseline from which to judge how a portfolio is performing and upon which your investment strategy is based. We work with our clients to help them formulate their unique risk/return assumptions. Based on what we discover we then have six individualized portfolio strategies where we put our client's assets based on these assumptions.

Tomorrow:  Part II