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Optimizing a Portfolio for 'Accumulator' Clients

It can make sense to take a bit of risk off the table for this type of client.

Michael M. Pompian, 01/22/2015

This month's article is the 13th and final in a series called "Deep Dives into Behavioral Investor Types." This series is intended to help advisors create better relationships with their clients by deeply understanding the type of person they are dealing with from a financial perspective and adjusting their advisory approach to each type of client.

As we learned in the last series, there are four behavioral investor types (BITs): the Preserver, the Follower, the Independent, and the Accumulator. If you missed any of these articles, you can find them in my MorningstarAdvisor.com archive.

We will discuss each BIT in a series of three articles:

Part I will be a diagnosis of each BIT and discussion of its general characteristics.

Part II will be a deep dive into the biases of each BIT.

Part III will cover how to create a portfolio for each BIT.

This article is Part III of the Accumulator BIT. (Click here to see Part I and Part II.)

Creating Behaviorally Modified Portfolios 
For today's financial advisor, private banker, or generalist wealth management practitioner, creating viable and unique investment solutions in response to the array of financial situations and personalities that clients present is the heart and soul of the job.

Sometimes the task is relatively easy: The client being advised appears rational in his or her approach--that is, he or she seems to understand the importance of asset allocation and has reasonable return expectations. For these clients, the typical method for arriving at an asset allocation is to administer a risk-tolerance questionnaire and use financial-planning software to create a mean-variance-optimized asset allocation program.

At other times, financial advisors encounter irrational behaviors in their clients. Irrational clients do such things as overestimate their risk tolerance, expect unrealistic returns, or generally behave in a way that makes advising them difficult because they are not grounded in rational investment principles and/or resist learning them. In these situations, risk-tolerance questionnaires and mean-variance software are often ineffective, but understanding and applying behavioral finance solutions can help clients meet their financial goals.

However, many advisors are vexed by their clients' decision-making process when it comes to allocating their investment portfolios. In a common scenario, a client, in response to short-term market movements such as what we witnessed in 2008 and more recently in the fall of 2011, demands that his asset allocation be changed--to the detriment of the long-term investment plan. This kind of behavior is a lose-lose situation for both the advisor and the client. The client loses because his portfolio is likely to underperform when he strays from the asset allocation policy targets (witness those who "sold out" in March 2009 only to see the market rebound dramatically). The advisor loses because he or she becomes ineffective and can even be blamed for the decision to change the allocation even if it was the client's idea. What to do?

Creating Portfolios for Accumulator Clients
Our process, as discussed above, is to review the basics of each BIT (done in Part I of this series), discuss the primary biases at work (done in Part II of this series), and finally discuss how to modify an asset allocation based on each BIT--in this case the Accumulator.

As we know, the Accumulator BIT describes investors who are interested in accumulating wealth and are confident they can do so. These BITs have typically been successful in some business pursuit and believe that they also will be successful investors. As such, they often like to adjust their portfolio allocations and holdings to market conditions and may not wish to follow a structured plan. Moreover, they want to influence decision-making or even control the decision-making process, which potentially can diminish an advisor's role.

At their core, Accumulators are risk takers and are firm believers that whatever path they choose is the correct one. Unlike Preservers, they are in the race to win--and win big. Unlike the friendly Followers, they rely on themselves and want to be the ones steering the ship. And unlike Independents, they usually dig down to the details rather than forge a course with half the information that they need.

Accumulators' risk tolerance is quite high, but when things go the wrong way (and they lose money), discomfort can also be very high. This discomfort may arise not only from financial loss but also from the blow to their confidence and the realization that they cannot control the outcomes of investments.

Some Accumulators can be quite difficult for advisors to build close relationships with, because these clients are attempting to make their own decisions rather than relying on the advice and counsel of their advisors. These clients are entrepreneurial and often the first generation to create wealth; they are even more strong-willed and confident than Independents. Left unadvised, Accumulators often trade too much, which can be a drag on investment performance. Furthermore, they are quick decision-makers but may chase higher-risk investments than their friends. If successful, they enjoy the thrill of making a good investment. Some Accumulators can be difficult to advise because they do not believe in basic investment principles such as diversification and asset allocation. They are often hands-on and wish to be heavily involved in the investment decision-making process.

Making Adjustments
Suppose you are beginning an engagement with a new client, Bob. You give him a standard risk-tolerance quiz and determine that he is an aggressive growth-oriented investor. After that, you give him a test for behavioral biases common among aggressive clients. Based on the answers to the bias questions, you determine that Bob is an Accumulator. Some of your other clients are aggressive growth-oriented in their risk tolerance, but they are not biased like Bob.

The object of this exercise is to figure out how to create an asset allocation for an Accumulator versus a non-biased or mildly biased aggressive growth investor. Generally, this means that an Accumulator should accept less risk in his portfolio than those clients without bias. Since Bob is an Accumulator, he may believe that he can control the outcome of his investments or may be overly optimistic about the portfolio's prospects, which could change the risk level in his overall portfolio if left unchecked. This makes working with an Accumulator somewhat more challenging than with some other BITs.

The following analysis presents two investment programs, one for Brandon (a non-biased aggressive growth investor) and one for Bob (an Accumulator). In this example, we are using Brandon's portfolio allocation as a baseline for creating Bob's. Your basic task is to assess a retirement goal for Bob and the risk associated with the return needed to reach that goal. When working with actual clients, you will need to adjust this analysis to suit your purposes.

As we know, Accumulator clients:

> Are driven by emotional biases.
> May believe they can control the outcomes of their investments.
> May be overly optimistic about the prospects for their investments.

For Bob, an Accumulator, we are going to assume he may have difficulty sticking to a portfolio with a probability of a loss year at greater than 45%. For Brandon, a non-biased aggressive growth client, 45% may be just fine.

Without getting too caught up in the details of the numbers, you can see below that Bob has a slightly less aggressive allocation than Brandon, which will likely permit him to reach his financial goals. This is an example of how one could adjust an allocation for the Accumulator BIT. 

Other Advice for Accumulators
Accumulators are often the most difficult clients to advise, particularly those who have experienced losses. Because they like to control, or at least get deeply involved in, the details of investment decision-making, Accumulators tend to eschew advice that might keep their risk tolerance in check. They are emotionally charged and optimistic that their investments will do well, even if that optimism is irrational. Some Accumulators also need to be monitored for excess spending, which, when out of control, can inhibit performance of a long-term portfolio. Other Accumulators make investments that align with their world-view but may not be the best investments for the long term.

For advisors, a reasonable approach to dealing with these clients is to take a leadership role. If the advisor lets the Accumulator client dictate the terms of the advisory engagement, the advisor will always be at the mercy of the client's decision-making (which is often emotionally driven), and the result will likely be an unhappy client and an unhappy advisor. Advisors need to demonstrate the impact that financial decisions have on family members, lifestyle, or the family legacy. If they can convince the client that they have the ability to help him or her make sound long-term decisions, they will likely see their Accumulator clients fall into step and become easier to advise.

Next month I will kick off a new series called "Behavioral Finance and Retirement." Thanks for reading!

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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