How to Rein in Stock-Picking Clients

The key is to focus on the investment process and not the product.

TODAY'S INVESTING environment offers so much temptation for your clients. As a financial advisor, it is your job to help them separate investing from speculation. By doing so, you perform perhaps the most noble role of the financial planning profession: You protect them from their worst instincts.

They absorb a daily barrage of stock information from social media, traditional media and boasting peers. Bitcoin news may have them wondering whether they should be betting on the transformation of financial systems. And they may perceive that day traders, or even their own children, are making small fortunes in the stock market. But investors are more likely to talk about their big winners than their losers.

How Clients Are Tempted to Veer Off Course

Diversions abound. Case in point: special purpose acquisition companies, or SPACs, which enter the market with nothing but their potential to buy a business and take it public. Pretty sexy, as stock picking goes.

Then there are so-called "meme stocks," which seem to offer the possibility of making a lot of money fast while beating those slick hedge fund managers at their own game. Lately, the places your clients can go to find get-rich-quick opportunities are seemingly endless.

By comparison, the sage advice you are providing may seem relatively mundane. How do you rein in their desire to get rich, while keeping them focused on staying wealthy? As exciting as it is to catch a highflier in time, taking risks in unfamiliar territory can reverse years of earnings from tried-and-true investing methods.

One thing that newer ways to speculate have in common: They involve selecting individual investments. That is, the investment is a single business or, in the case of cryptocurrency, a single financial vehicle. Unlike the exchange-traded funds, mutual funds and separately managed accounts, or SMAs, you may have used in portfolios for years, there is no safety in numbers with these types of investments. Even if a client is invested in a group of highfliers, when the SPACs hit the proverbial fan, high-risk investments tend to rise and fall together.

How to Keep Clients on Track

Project adaptability. Rather than put yourself in the position of looking like a buzzkill, acknowledge the client's desire to get something different from their portfolio. Refocus them on your ability to give them options while protecting their assets.

Revisit your investment process. Make sure it is flexible enough to account for this phase of the market cycle. Your clients may be asking for something that even they cannot pinpoint. They may be curious about a popular stock or group of stocks, but only because they just saw them go up in price. What they are really looking for is something in their portfolio with the potential for strong short-term gains.

Take a different tack. Tactical investing used to be frowned upon by the profession. This method devotes part of the investment process to profiting from price moves that occur over weeks or months, rather than years. However, not devoting some portion of client portfolios to tactical methods has become a risk to many advisory practices because the markets do not work the same way they have in the past.

This is particularly true in subsegments of the stock market, such as sectors, industries and factors (high dividend, low price-earnings ratio, etc.). Thanks to algorithmic trading, the explosion of ETFs and the instant transmission of information, major price moves occur in a fraction of the time they did before. This helps explain how the S&P 500 could lose one-third of its value in about a month, as it did around this time last year. If at least part of a portfolio does not account for this type of change, it may fall behind.

Embracing tactical investing can help you replace your client's desire to speculate on individual stocks with your willingness to pursue short-term profits as a sidecar to their long-term portfolio. Tactical investing, either through ETF rotation or via funds that do the rapid rotation for you, is a way to confront a client's concerns without making them into a confrontation with the client.

Build client desires into the plan. Journalists often start an article with the key takeaway and get increasingly detailed as the story continues, like an inverted pyramid. In investing, the inverted pyramid means that you focus on the most important long-term items first, then develop your investment plan in more detail from there. The development of such a plan goes like this:

- What is your investment philosophy? What is the high-level approach you aim to take?
- What is your investment strategy? How are you going to pursue that philosophy, using the tools of the trade?
- What is your investment process? This involves the repeatable, sustainable steps you take to analyze each investment and determine if and how it fits the portfolio plan. What research methods will you prioritize to maintain an armory of "battle-ready" investments?
- How do you construct your portfolio? What are the allocations, limits and guidelines?
- What goes into the portfolio, how is it evaluated on an ongoing basis, and what are your selling and upgrading criteria?

As you can see in the five points above, questions about buying a specific stock do not enter the picture until the final point. By then, your research process has already either allowed for that stock or it has not. Instead of breaking the plan to incorporate an allocation to highfliers, find a way to enhance the plan to comfortably include them, subject to certain conditions.

If this method sounds rigid, that's because it is an organized process. If you've previously outsourced this part of your job to a third party, you may be missing a key insight into client retention and growth in the next decade: In markets that do not just go straight up, your investment process matters. If your process is a tight one, it already accounts for a wide variety of client inquiries, including those symptomatic of a case of FOMO, or "fear of missing out."

If you simply bad-mouth investments that you believe are not the right fit for your clients, you risk making them think that you are working against them. Instead, find a way to discuss any investment idea they bring to you in a way that relates to your overall plan for them. Taking big shots with small amounts of money may be acceptable for some clients. But as you do with everything else, find a way to put that in its proper place in the plan.

Related: How to Explain Hedging Concepts to Clients