Submitted by Melissa Glennie - Professional Issues Committee

Optimizers: What are they? What do they do? How do they do it? Are financial planners using optimizers? Should they? Is 2017 the year to implement an optimizer in your practice?

But first, a few words from Harry Markowitz, the 1990 Nobel Prize Laureate in Economics, on ‘How to Lose Money.’Markowitz wrote, “The first advice towards achieving poverty… is to invest in the hottest stocks in the hottest sectors.”

What we should do instead, Markowitz believes, is to squeeze the best returns with the least amount of risk out of portfolios of different asset classes. To do so requires us to analyze the effects of asset risk, expected returns, correlation and diversification on expected portfolio performance. Portfolio optimizers are the engines which help us choose the proportions of various assets to be held in a portfolio in such a way as to make the portfolio optimal – lying on the efficient frontier, and accurately reflecting the investor’s expressed preferences regarding expected return and risk, as measured by standard deviation.

The optimizer output determines the asset allocation which is most likely to get the desired risk and return attributes – and therefore, benefits of asset class diversification – for a particular client.And yet, industry surveys indicate there are many advisers not yet using an optimizer.

I believe 2017 is a good time – yes, right now – to implement a portfolio optimization process within your practice.With our current bull market in equities, this is an excellent time to be discussing portfolio risk with clients, and documenting those discussions.

As financial planners and investment advisors, we all know that we need to document how we are performing our responsibilities as a fiduciary to our clients. This is necessary for a number of reasons. Regulators are increasingly looking for documentation. Without being able to prove our asset allocation construction procedures, monitoring those portfolios, and knowing the client’s situation as well as risk tolerance, we will be in hot water with regulators. And, if one were to find oneself with a client complaint or arbitration, one will need strong documentation to defend oneself. The output of an optimizer would certainly help achieve the documentation needed in such an unfortunate situation.

Without regard to whatever happens to the April 2017 ‘start date’ for the DOL Conflict of Interest Rule, our clients expect us to act as their fiduciary. An Optimizer could be a tool used to evaluate and validate recommendations made to clients. There are many choices of software programs for advisors to evaluate and choose one that best fits their needs.

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