As a successful accountant, you are no stranger to risk. Whether working with individuals or business owners, you help your clients navigate a wide variety of economic, regulatory, political and personal factors to make the best possible financial decisions. And those factors are constantly changing.
In daily life, risk is the probability of something bad happening based on the actions you take. Take investment risk. For investors, risk is the likelihood that their actual return will differ from their expected return. To understand what is happening in a portfolio, investors must understand risk. It’s a fundamental premise of investing that the more risk you are able to tolerate, the greater your potential return can be. For instance, growth stocks experience far more ups and downs than U.S. Treasury bills and hence are much riskier.
You may not be advising your clients directly on their investments, but you owe it to them to make sure they are in touch with their risk tolerance and that they’re working with an advisor who takes that risk tolerance and their financial goals into account when constructing their portfolio.
Some investors are risk averse. Others embrace risk wholeheartedly. Most are somewhere in between. Whatever your client’s risk tolerance, the potential return on their investments should be commensurate with the amount of risk they’re willing to accept. That means understanding all the various sources of risk, managing them prudently, and using that knowledge to make better financial decisions even when the market is volatile and emotions are running high. As General George Patton famously said, “Take calculated risks. That is quite different from being rash.”
Managing risk
Managing risk is highly complex. Fortunately, there is powerful software that can assess thousands of different risk factors pertaining to securities and investments. When your client’s financial advisor connects these factors to their individual goals and helps drive risk-appropriate solutions, they can accomplish three important things:
- Understand which accounts and specific holdings are driving your client’s overall risk, using sophisticated risk analytics.
- Illustrate, hypothetically, how different market events might impact your client’s current holdings and overall financial future.
- Explore strategies to shift and mitigate some of the embedded risks your client is facing.
If your client’s financial advisor is not able to provide this type of analysis, it might be worth making a change. Doesn’t it make sense to learn about the portfolio risks your clients are exposed to before something catastrophic happens that can derail their client’s retirement cash flow and financial future? It’s essential to consider risk, not just within your client’s portfolio, but across their entire financial picture.
By understanding the specific drivers of portfolio risk, you can help your clients and their financial advisors work together to model potential changes.
We can’t control the markets. But we can help clients understand risk, manage it and use it to drive appropriate financial decisions.
Many of our new clients believe they have a diversified portfolio because they hold mutual funds from different fund families. Usually, they’re not as diversified as they think. After conducting our mutual fund overlap analysis, we often find that many of their funds hold the same stocks, leading to unintended overexposure to specific companies or sectors. This overlap reduces the diversification benefits of the portfolio, as multiple funds essentially replicate similar risks. By identifying and reducing these redundancies, we can create a more diversified, balanced allocation that further minimizes risk and aligns with the client’s goal of stable returns.
Real-world example
A client told us they were well diversified because they owned a variety of mutual funds and exchange traded funds from several major fund families. After seeing our overlap report of their holdings, however, they were taken aback. Like many investors, they had a great deal of stock overlap in their mutual funds and ETF portfolios because those different funds held many of the same stocks. This increased their concentration risk and reduced the benefits of diversification.
This overlap can expose investors to heightened market volatility and to potential underperformance if the overlapping stocks decline. For taxable accounts, mutual funds present an additional risk due to potential capital gains exposure. That’s because fund managers may distribute gains from sales of long-held assets, resulting in unexpected tax liabilities. To reduce these risks, investors and their advisors should (a) analyze fund holdings for overlap, (b) diversify across investment styles and asset classes, and (c) prioritize tax-efficient ETFs or index funds. Regular portfolio monitoring and rebalancing can help address these challenges and maintain a well-diversified, tax-aware investment strategy.
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