It’s probably happened to every investment advisor at one time or another – a client wants to do something unusual and likely very unwise with some of their money.
It can range from buying into a speculative penny stock to bankrolling a family member’s start-up business or going all cash in times of uncertainty.
“There’s always something in the media, always some stock tip or some desire to gamble,” says Jason Pereira, partner and senior financial consultant at Woodgate Financial Inc., a financial planning firm under the IPC Securities Corp. umbrella in Toronto.
“They want to have ‘playtime.’ It can be a small-cap stock tip from a buddy, or they love a product but don’t understand how the company can’t be worth a fortune in the future,” he says.
Mr. Pereira says these very high-risk investments don’t always go wrong.
“I have a client who bought a ton of Tesla Inc. TSLA-Q stock way back – and boy did that work out,” he says. “Someone else wanted to speculate in bitcoin BTX21 three years ago – that’s [also] worked out. But, just as often I get statements back and the asset value is zero. It happens.”
I have an 85-year-old client right now that has an investment in a manufacturing company outside Toronto – he’s going to die before that thing hits a cash-out.
— Jason Pereira, Woodgate Financial Inc.
When it comes to handling high-risk ideas and clients requesting investments that are not suitable for them, Mr. Pereira says advisors still face liability.
“Simply marking it as ‘unsolicited’ is not enough,” he says. “We’re still seen as gatekeepers – and can still be held accountable if they lose money.”
The key questions to ask
Mr. Pereira asks a series of questions in these situations. Is the investment going to hurt their long-term objectives? Do they have excess capital in their financial plan that they can play with? Or, are they already in financial difficulty – and therefore shouldn’t be doing anything like this?
“If it’s the latter, I discourage them from doing it. If it’s the former, I say, ‘Look, if you want to carve off x amount of dollars, and basically go play with that, you’re welcome to, but it doesn’t make sense to do it through me,’” he says.
In these cases, he tells them to use a separate account at a direct/online/discount brokerage. “At the end of the day, if they want to have their play accounts, I don’t want to be responsible for that.”
Mr. Pereira has also had to deal with clients who want to make private investments – buying into business ventures that aren’t listed on a stock exchange or registered with a securities regulator.
“Everything from air purifiers to someone working on a chemical that looks like it’s going to work for some kind of treatment – all this stuff tends to be very, very, early stage, and highly speculative,” he says.
“I have an 85-year-old client right now that has an investment in a manufacturing company outside Toronto. He’s going to die before that thing hits a cash-out,” Mr. Pereira says.
These investment ideas often come from a friend or family, he says, and there’s much misunderstanding about what it actually means.
A key question clients should ask when considering these private investments, Mr. Pereira, is, “When can I get out?” In many cases, there’s no formal partnership agreement spelling out how and when the investor will be paid back.
If there is an agreement, the payout will only come when there is an exit – such as the business being sold. In addition, there is often no secondary market to sell the investment.
“There are stories that work – look at what happened with Trivial Pursuit,” he says. “But more often, it’s a graveyard of failure.”
How to make it work
John De Goey, portfolio manager at Wellington-Altus Private Wealth Inc. in Toronto, says he tries to find a way to make these investments work if the idea is only a bit off course, can be accommodated with a small amount of money, and is within the client’s risk profile.
“Modestly odd ideas are not the sort of thing I would resist if pursued in a modest way,” he says. “Anyone who wants to put up to 10 per cent into something that I would not ordinarily recommend can get the trade, provided it fits their overall strategy.”
He gives a contrasting example of a client inheriting $260,000 of Bank of Montreal BMO-T stock and if the client doesn’t mind the concentration – or perhaps doesn’t want to trigger a large capital gain – then he will happily build the portfolio around the single security with a possible future schedule for selling down some of the position.
Mr. De Goey says the exception is if an investment idea is “egregious.”
“The definition of egregious is open to interpretation, but my view is that anything well beyond the purview of the client’s risk profile is a certain no-go.” For example, he says he doesn’t trust cryptocurrency as an investment “for anyone.”
The first step in Mr. De Goey’s process is to speak to the client directly in order to understand their motive. “Sometimes, it’s a hot tip from a brother-in-law or an article from Facebook.”
Mr. De Goey says advisors should watch for unproven stocks or ideas suggested by clients, and mark all such trades that they take as unsolicited.
Advisors should also keep good notes about what they agreed to and why. Then, once an agreement is made to proceed in some manner, he recommends trying to get something thematically consistent, but more diversified.
He cites the example of a client wanting to put $10,000 into a single blockchain stock. A better approach may be convincing them to invest in a blockchain exchange-traded fund as the biggest risk may not be the general thesis, but rather the individual unproven company.
“Basically, the idea is to switch the mindset from, ‘What could go right if this works?’ to ‘What could go wrong if it doesn’t?’”
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