4 basic knowledge when investing other people’s money

Advisors who manage the funds of others must comply with the applicability of Financial Industry Regulatory Authority (FINRA) Rule 2111. This rule came into effect on October 7, 2011 and legally requires consultants to serve their clients’ best interests. In order to comply with the rules and determine suitability, consultants must consider the client’s risk tolerance, preferences and personalities, financial situation and investment objectives.

Key points

  • As a financial adviser, managing the funds of others requires a lot of ethical and regulatory responsibilities.
  • Allowing customers to make the right investment means that the appropriate level of risk and time frame is likely to meet the customer’s financial goals.
  • Placing clients in inappropriate investments may be because the investment is too risky for their personal preference or objective financial situation or both.

1. Understand risk tolerance

Advisors know that understanding the client’s risk tolerance is crucial. In other words, their ability to withstand losses. For example, for investors who cannot afford to lose their principal, investing in stocks or even most fixed-income investments may not be appropriate. However, in the long run, investors who can better handle losses are more likely to generate higher returns.

The time frame can also be related to how much risk the customer should bear. For example, a customer with a 20-year time span may have a higher risk profile because in the long run, the return may be equal to the historical market return. Customers who plan to retire within five years should have a lower risk profile because they have less time to recover from a sluggish market.

2. Preferences and Personality

When determining the right investment, consultants often ignore the client’s preferences and personality. If customers are relatively new to investments, they should avoid using complex strategies such as options or derivatives. They must educate new investors about how each investment works so that they understand what is happening in the portfolio.

The consultant should also know whether the client has any negative views on any industry or company. For example, investing in alcohol or tobacco companies without knowing the opinions of customers may cause problems in the investment relationship. If a client makes a request, investigating funds with a “sense of social responsibility” is a good way to show that you understand that they exceed their financial goals.

3. Current financial situation

Understanding the current financial situation of customers is arguably the most important of the four points in this article. Compared with customers with low tax rates, customers with high tax rates may benefit more from investing in municipal bonds or tax-deferred savings instruments. Understanding the liquidity needs of customers is crucial. If the client needs immediate access to funds, advisors may avoid investment tools such as annuities or long-term bonds, because early withdrawal of these investments may result in surrender fines or negative pricing.

4. Investment objectives

Traditionally, most people think that investment is a way to make money or earn interest, but they ignore the setting of investment goals. Providing a client with investment goals helps him better understand what he wants to achieve. For example, a consultant who knows that a young couple’s goal is to pay for their children’s college education might suggest a 529 college savings plan.

Understanding the customer’s needs can not only build trust in the relationship, but also better allow the consultant to change the customer’s personal information during the process to ensure that the plan is consistent.

Bottom line

In general, investment professionals need to understand the client before making investment recommendations. The more information collected, the better the adviser’s ability to choose the right investment. Not knowing the customer may result in inappropriate investment advice or loss of the customer’s principal, and may violate FINRA Rule 2111.


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