Goal Based vs Transaction Based Financial Planning

I received an email over the weekend asking me how to invest a substantial cash position.  As I am not yet designated yet as a Registered Investment Advisor,I couldn’t provide specific advice.  However, I found my response to be an interesting example of the differences in the planning world, it highlights not only the difference between transaction based ‘planning’ and goal based planning, but also the limitations of Robo-Advisors.

I have a number of friends that work (or worked) at the wirehouse firms of Morgan Stanley, Merrill, and others.  I could imagine their response to the email.  It would be ‘absolutely, I recommend product A, B, or C.  Same with the Robo Advisors, you fill out a 30 second risk profile online and it would suggest asset allocation X.  It’s a transaction in both cases, even when it is listed as goal.

The answer I gave was that I had no idea what to do with the money.  Looking at a lump sum in isolation is dangerous as you could create a severely unbalanced overall position.  Even if you created a well diversified portfolio with that lump sum, it might well skew the total asset base far from the desired risk tolerance, and without knowing more about goal setting, it would be bad advice.

My approach to planning is that goals should be set, present assets calculated, and we should explore if there is a gap between where we are today, and where we need to be to achieve life goals, then risk and return should be modeled to create the least risky way to get to that goal.  That means that even if a person comes to you with $100,000 and says they are ready to invest 100% in equities, a planner should sit down and calculate if that investment risk is necessary.

My firm will be launching sometime in the next 6 months, and I think I am going to find it an interesting challenge to re-align thinking from ‘give me a product for this money’ to ‘what do I need to do to ensure I meet all my life goals’. I think client screening will be important here, and wonder how much ‘the customer is always right’ comes into play with such things.  Personally, my inclination is to think that if someone comes to me looking for a transaction, they are less aligned on a long term plan and more likely to act with irrationality should the investment not produce its theoretical returns.

One such thing on this that I have been exploring recently is DFAUS (Dimensional Fund Advisors) they only ‘sell’ through Fee Only planners. Investors are very interested in these funds, and I wonder if the allure is someone akin to the desire for people to invest in hedgefunds.  DFAUS  offer exclusivity, and offer good returns, but does that bring with it intrinsic problems as a planner, as your clients seek to focus on the product, not the goals.

What do you think, do you need a long term plan every time, or is an investment tool, such as offered by a Robo Advisor sufficient to meet your needs?  If you are happy with a solution like Betterment or Wealthfront, do you see a need for an independent financial planner at all?