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Achieving success in investing starts with making informed choices that take into account the investor’s true risk tolerance and time horizon. Staying invested and sticking to a disciplined strategy are both key to meeting investment goals. The best advisors play a critical role in educating and advising investors at the beginning of the relationship, staying connected as markets change, and coaching when emotions can lead to rash decision-making.
A challenge we often see is investors who may not know their real risk tolerance until they face market downturns. Some may describe themselves as aggressive investors but find that they lack the conviction and confidence needed to stick to their strategy when markets drop. The amount of loss they can accept may be a good deal less than what they state when making investment decisions.
Great advisors help clients realistically assess their risk tolerance. They help clients remember how they have acted before in challenging times and understand that past behavior can be an important indicator of future actions. They know that two investors with nearly identical income needs, family situations, and financial goals may react in different ways when volatility hits. That’s why those early conversations between the advisor and the client that elicit a more accurate picture of risk tolerance are so critical.
What Diversification Really Means
Another challenge can be the investor’s understanding of diversification. Many investors equate owning a long list of securities with safety. But if those securities move together, the protection is limited. A high degree of correlation signals a lack of true diversification.
Real diversification comes from understanding how assets interact with each other and how they behave in different market environments. Advisors and portfolio managers can play an essential role in showing clients the difference between simply having more investments and having the right mix of investments.
There can also be subtle barriers that keep people from making rational decisions. For example, taxes loom large. A stock that has appreciated significantly can feel untouchable, even if trimming it would improve the portfolio’s balance. Popular names with strong recent performance can also feel hard to part with. As a stock appreciates, the story can feel too good to interrupt. Stocks that appreciate rapidly could at times struggle to continue momentum.
Another barrier is when investors look to chase recent hot areas of the market, thinking they have potentially missed out on great opportunities. The client may push to change their original allocation to try to “catch up.” A good advisor will help the client understand that they may have and will continue to benefit from the trend within other parts of the portfolio, even if they don’t feel they have benefited enough.
Ongoing Emotion Management
All of these situations can be an emotional trap for an investor. Without guidance from their advisor, investors often let these situations drive decisions and allocation changes. Proactive conversations about rebalancing, harvesting gains, and shifting narratives can neutralize these emotions before they become costly mistakes.
Advisor education and communication can tie all of this together. A single conversation about risk or rebalancing is rarely enough. People need reminders. They need to hear the same principles repeated when the market is rising, falling, or remaining calm. When headlines or friends bring the next great idea to the table, it can be the steady, trustworthy voice of an advisor that keeps a solid, long-term plan intact.
A key part of effective investing is behavioral. For investors, it means truly knowing their genuine tolerance for risk and how they are likely to react to various market conditions. For advisors and portfolio managers, it means forging strong relationships with clients and constantly reinforcing strategies put in place.
The math is important, but behavior can be what ultimately determines success.
Lee Grout, CFA, is a senior portfolio manager at NewSquare Capital.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
