“Many are stubborn in pursuit of the path they have chosen, few in pursuit of the goal.” So goes a famous quote by Friedrich Nietzsche. Nietzsche may not have had a retirement portfolio of his own, but investors today can really benefit from his wisdom. In an era characterized by the compounding complexity and quantity of financial products, the multitude of asset classes and investment products on the shelf may perplex investors. It might even divert them from their original goal. Is there clear a sky in the midst of all this fog?

Yes, there is—a message heard loud and clear at CFA Society Toronto’s 2014 Wealth Management Conference. Speaking at the event was Ron Florance, CFA, deputy chief investment officer at Wells Fargo Private Bank. He laid out an intuitive and easy-to-follow approach for investors to get the most out of their portfolios. “It is time to change the conversation,” Florance explained. “Focus on the ultimate goals and ask ‘What do I need the money for?’ rather than ‘What do I own?’”

How would that help? For starters, it would result in a significantly better asset mix than a selection process based on past performance or value judgments would. Second, the asset mix would be more relevant when the investments are selected, given some context and not just based on risk and reward as represented by mathematical constructs. As Florance explained, investors don’t approach their advisors seeking guidance on how to reduce the annualized standard deviation of their portfolio.

Similarly, reward is much more than total return. It could mean cash flow, liquidity, security, or tax efficiency, depending on the investor’s circumstances. To tackle these problems, Florance suggested six scenarios that would typically address investors’ concerns in the quest for a better-performing portfolio.

SCENARIO-BASED PLANNING

The first scenario is planning for catastrophic events. These can “radically change the landscape and create extreme distress in the capital markets,” Florance explained. A portfolio that minimizes the downside risk caused by these events reduces irrational actions by investors.

Similarly, planning for unexpected events and unforeseen opportunities, the second scenario on the list, would allow access to liquidity in case the “unknowable” occurs. This could be anything from an illness to a business opportunity.

Once ample liquidity is ensured, Florance presented three scenarios that could lead to actions detrimental to the overall portfolio. “The failure of your sources of income to meet your income needs, which is distinct from liquidity,” is another scenario that should be considered, he said. Similarly, rising inflation, which corrodes value, and market volatility, which causes value to oscillate, are two other scenarios that should be built into the portfolio. There are ample choices for products that provide support against these harmful forces of nature.

Finally, he suggested that investors should consider “an allocation for maintaining sufficient assets to support your lifestyle and meet desired future needs.” According to Florance, when all of these scenarios are considered together, the resulting portfolio is not just easy to understand but actually helps achieve the investor’s goals. The table below, based on these scenarios presented by Florance, illustrates a sample allocation for a hypothetical portfolio.

After defining the investor’s goals and structuring the portfolio to address these scenarios, half the battle is won. The other half of the battle is actually attaining those goals. Just like a diet program, it is actually quite hard to follow in practice, as Florance said, reflecting on his experience with clients.

To address this challenge, Florance laid out seven principles that can act as a guide for investors. Here is a summary of these key principles:

1. Know your number – the amount of cash that provides comfort and a cushion to withstand volatile markets
2. Know your time horizon – the different timelines for each of the investment goals
3. Manage your financial goals and strategy on an ongoing basis – circumstances, objectives, and risk tolerance all change with time; so should asset allocation
4. Diversify for consistent returns – stable returns are more likely to result in a better-performing portfolio
5. Know your risks – look beyond volatility; consider other risks such as leverage, illiquidity, etc.
6. Follow the process and stay disciplined – consider worst- and best-case outcomes to help filter out emotions
7. Be a global investor – embrace the global economy we live in

Florance’s clarity in explaining these principles should not conceal the challenges they pose for those who try to follow them. Reflecting from experience, Florance mentioned that, “Investors’ time horizons tend to lengthen in good times and shorten when markets are distressed.” There is also plenty of literature on other behavioural biases that plague investors, and it is no secret that maintaining discipline is in itself a big feat.

Understanding the ultimate goals—and adhering to a structured approach for reaching those goals—will certainly help investors get better results from their portfolios. That was the essence of Florance’s presentation, and it is a reality check for investors contemplating ever more complex investment strategies. As Nietzsche might have asked: What good are those strategies if they fail to achieve the goals they are designed for?