Financial advisors often are repelled by the idea of making financial market forecasts. Advisor training stresses strategic asset allocation with periodic rebalancing, which traditionally has focused on risk. But there are good reasons for estimating future returns in order to apply a return-suitability check on recommended client portfolios.

Advisors who bring clients through a good discovery process know what total return their clients need to meet their goals over their holding periods. You should recommend a portfolio to meet a client’s stated return target while conforming to his or her risk preferences. If your client is not comfortable taking enough risk to hit this return target, then that’s an opportunity to have a discussion to close that gap.

Some way of estimating the performance of a recommended portfolio is required to make this assessment. Otherwise, you’re just shooting in the dark. This concept also is tied directly to the issue at the heart of virtually every client/advisor dispute – suitability.

Suitability is usually framed in the context of a product. Regardless of your dealer’s or your primary regulator, regulations require that you be adequately informed about your client’s objectives and goals prior to making recommendations or selling any products.

Similarly, both you and your dealer must perform sufficient due diligence to understand the products being sold so that there’s a reasonable basis on which to assess whether a product is suited to a client.

Although this exercise is almost always risk-focused, both return and risk should be considered to assess suitability fully. This requires a supportable way of estimating future returns.

Advisors buying into this notion of return suitability face two big hurdles. First, few advisors have a good method for estimating future long-term returns.

A dozen years ago, I began providing clients with return projections using a model that I developed from a combination of proprietary research and borrowing from the work of some of our global industry’s great thinkers.

Even if you develop your own method, there is a second hoop to jump through – compliance.

Your compliance officer (CO)will be concerned about the projection method you use, how you communicate the method’s output to your clients and the use of disclaimers. This sounds daunting, but a method with good support from reputable third parties is a good start in winning over your CO. Not putting specific figures in writing – i.e., speaking more generally with your clients – will also ease concerns and minimize the length of the required disclaimers.

Both your CO and clients should be pleased with this enhanced suitability assessment, which addresses risk and return in the context of client goals and objectives.

Dan Hallett, CFA, CFP, is director of asset management for Oakville, Ont.-based HighView Financial Group, which designs portfolio solutions for affluent families and institutions.

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