Morningstar Advisor - April/May 2013 - (Page 7)

Letter From the Editor Risk Preparedness Jerry Kerns Follow Jerry on Twitter @ jerrykerns Advisors are thinking about all kinds of ways to help their clients manage the investment risks in their portfolios. A few of these ideas appear in our On Topic page (Page 10). They range from basic diversification to more complex strategies. Melissa Joy, CFP, a partner and director of investments and client services at Center for Financial Planning in Southfield, Mich., has some ideas, too. She and her team set aside cash for clients’ short-term liquidity needs, “so clients do not need to deviate from their investment plans during market disruptions.” When her team selects investments, they review rolling-return periods, upside/downside capture, and beta to better understand the risks specific to an investment. They do a scenario analyses to model their portfolio constructions. “We don’t think that this gives us a crystal ball, but it helps us to ferret out unanticipated consequences in portfolios.” They also ask clients to reduce their concentrations in individual stocks that have formed from large legacy positions, inherited stocks, and company-stock ownership. They rebalance portfolios by setting “tolerance bands,” predetermined ranges within any given asset class. If positions drift outside the bands, the firm reviews the positions and rebalances the portfolio. They also use alternative assets, such as managed futures, mergerarbitrage strategies, and long-short strategies, to incorporate investments that are less correlated to traditional stocks and bonds. Advisors are acutely aware of the risks of investing, and as Joy’s examples illustrate, they put a lot of effort and thought into trying to mitigate the risks their clients are exposed to in their portfolios. It’s commendable and effective. Investors with diversified portfolios likely got through the financial crisis in better shape than people whose portfolios had become out of balance. But diversification mitigates risk; it doesn’t eliminate it. When something unexpected happens, an economic cycle abruptly ends, a bubble bursts, or correlations head to one, portfolios plummet, some more than others. The fearful will flee, the smart will buy. And so it goes. Behavior Gap columnist Carl Richards often talks about the importance of focusing on the process, instead of outcomes. Advisors and investors can control the former, they can’t control the latter. You can be the smartest investor in the room, do everything right to build a portfolio to withstand any known risk event, and still underperform the guy throwing darts. But which type of advisor would your client rather have during a time of crisis? By guiding the process, as planners such as Joy do, advisors are in position to help clients stay the course in the face of risk and uncertainty—or, if necessary, make adjustments or new plans to ride out the storm. Instead of trying to avoid all risks, which is futile, the best advisors are honest with clients about their risks and shepherd them through the ups and downs. Sure, there are worthwhile strategies that can mitigate investment risk, and we talk about some of them in this issue. But that won’t stop the unforeseeable from happening. Clients should know that up front and be prepared, and get a good night’s sleep, thanks to you. 7

Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2013

Morningstar Advisor - April/May 2013
Letter From the Editor
The Pursuit of Happiness and Financial Advice
What Strategies Do You Use to Control Risk?
Driven to Succeed for Clients and Family
How to Assess a Portfolio’s Bond Risk
Luck, Skill, and Investing
Investments á la Carte
Investment Briefs
Investing’s No- Brainers Have Costs
A Defensive Ride
Risk On/On Risk
The Risk of Being Overconfident
Year of Living Dangerously
The Risk-Parity Approach
A Guide to Mutual Funds Running Risk-Parity Strategies
What Moats Tell Us About Risk
Risk’s Wake-Up Call
Seeing Is Believing
Why Investors Lag the Returns of Their Funds
Liquidity Signals
Pump Them Up
Golden Oldies Keep on Truckin’
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Our Social Blind Spot

Morningstar Advisor - April/May 2013