More than three-quarters of retail investors say they would prefer a protection-focused portfolio to one that outperforms the market, so what’s an advisor to do?
The Cerulli Edge?U.S. Retail Investor Edition, 3Q 2018 Issue explores how balancing downside protection with the growth potential necessary to help investors reach their wealth accumulation goals is one of the most challenging scenarios facing financial services providers. The report compares the responses of protection-focused investors with their performance-seeking peers to help better understand the dynamics facing participants in the retail investor market.
“Financial services providers and advisors frequently focus on beating their benchmarks, but investors prefer an emphasis on downside protection by a three-to-one margin,” says Scott Smith, director of advice relationships at Cerulli Associates.
When viewed by wealth tier, the highest concentrations of this preference are among investors with $250,000 to $500,000 (83%) and greater than $5 million (80%). This underscores the challenges that advisors and providers face, as those in the higher wealth tiers can afford to take this approach, but those in the $250,000 to $500,000 range may not be taking on the market risk necessary to achieve their accumulation goals, the report explains.
This reluctance appears to not have changed much over the last several years. When asked whether they are “protection-focused” or “performance seekers,” the protection-focused respondents have hovered at 77% to 78% since 2013, with a low of 74% in 2014, while the performance seekers have hovered around 23%. These protectionist tendencies are further echoed when reviewed from an age perspective, with the highest levels among those over age 60 and under age 30.
In perhaps somewhat of a surprise, advisor-directed investors, who fully outsource control of their investment to their advisors, express the highest degree of wealth protection preference at 84%, but even fully self-directed investors adopt this stance overwhelmingly (77%), the report notes.
Overall, the report shows that protection-focused investors (63%) report higher incidences of ongoing advice relationships with a specific advisor than performance seekers do (54%). Protection-focused investors, meanwhile, tend to prefer a “more nurturing service model” than those focused on higher returns. However, the report emphasizes that both segments can benefit from ongoing advice and reinforcement of positive financial behaviors. Whenever possible, providers should align their models to allow investors to opt into recurring contact options with dedicated teams or individuals, the report suggests.
It warns, however, that the gap between investors’ preferences and accepted best practices in long-term portfolio construction leaves providers “facing the real threat of disenchanted customers when markets struggle.” It cautions that, when faced with adversity, investors will frequently find fault with incumbent providers, regardless of previous gains.
The report suggests that to best meet the expectations of each segment, providers will need to “dig deeper on the trade-offs” that individual investors are willing to make in balancing returns with security. “To help bridge this gap, providers must make every effort to help investors view their appetite for risk in terms of their risk capacity, rather than independently,” Smith suggests.
While establishing a baseline agreement on appropriate portfolio risk is essential in account initiation, discussions on the topic must be a recurring part of an advisory relationship to reinforce the likelihood of down markets and to help view them as “opportunistic discounts rather than tragedies,” the report further advises.
