How goal-based advice combined with a realistic risk framework helps wealth managers grow their business and reduce risks

We believe that goal-based advice is superior to any other form of investment advice as clients always have financial goals. All clients have at least one goal in mind when they invest, even if they only want to increase their wealth or minimise losses. This type of investment advice requires a realistic risk framework which enables accurate wealth projections and a superior user experience.

Todays’ advisory processes rely mostly on outdated, single-period risk frameworks: take the example of Markowitz, a methodology from mid-last century and yet widely used in investment management.

The basic assumption of this methodology is that returns are normally distributed and that the expected returns do not change over time. Most wealth managers still use conventional single-period risk frameworks like Markowitz although it has been proven empirically that returns are not normally distributed: one proof is that capital markets have had higher losses than gains in the past. Negative returns have been observed both in greater magnitude and with a higher probability compared to the ones implied by normally distributed returns (so-called ‘Fat’ Tails).

This mismatch results in a significant liability risk of the wealth manager: all investment portfolios derived from conventional risk frameworks consequently carry a higher downside risk than projected.

Additionally, conventional risk frameworks do not include the clients’ financial goals, savings or liabilities which are all needed for professional financial and wealth planning. Hence, a sound wealth development cannot be forecasted considering the clients’ financial goals. Further, key wealth parameters like inflation cannot be integrated into the wealth forecast, aggravating the above outlined liability risk of the wealth manager.

To overcome this, wealth managers need a risk framework which is realistic and generates investment recommendations that best fit to the individual situation of the client. Therefore, a multi-period stochastic optimisation risk framework should be used: it simulates wealth development based on the clients’ financial goals accurately and mitigates the liability risk for the wealth manager.

With a multi-period risk framework, a goal-based advisory solution can also be significantly improved: the ideal goal-based advisory solution is responsive (reacting to changes instantly), holistic, individual, and includes the wealth manager’s specific market view. Some of that functionality is enabled by the multi-period risk framework:

Register to our Webinar to find out more and how your advisors can be supported through our solution to grow their business, both from existing or new clients.

Author:

Marc Mettler, Head of Business Development, 3rd-eyes AG

Email: marc.mettler@3rd-eyes.com

LinkedIn: https://ch.linkedin.com/company/3rd-eyes

Web: www.3rd-eyes.com

Join Marc Mettler on a webinar entitled ‘How Digital Wealth Planning can Help Your Financial Institution Grow AuM and Revenue‘ by 3rd-eyes on 7th March at 3PM London/10AM New York.

Register Here!

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