27 June 2024

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The Value of Restriction

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The restriction has a value. But what restriction are we talking about?

The liquidity (or marketability) of financial instruments, which is the ability to liquidate an investment through direct sale on the secondary market, has become an almost assumed characteristic of (almost) all managed savings products over time.

In the initial phase of financial planning, and later during asset allocation, the financial advisor presents the client with the usual question: "For how many years do you think you can invest your money?" This question aims to understand, and help the client understand, whether those funds can be invested in instruments that require a certain time frame to realize their benefits. This question is also present in the profiling questionnaires. However, once it is established that the client is willing to invest for the medium to long term, it is often added that by investing in funds/ETFs, they always have the option to reclaim their money by requesting redemption and receiving a payout within a few days. But if it is intended that part of the client's assets should be invested for the medium to long term, especially to meet vital future needs, wouldn't it be better to impose a specific restriction? If, as they say, investment in markets (especially equity) yields its best effects for those with the discipline and patience to wait, why allow the possibility of exiting before the time is due? If the client might need it in an emergency, the asset allocation should already include an adequate portion of liquidity for emergencies.

The idea of restriction is (genetically) innate in the minds of many savers. Sophists in the field would call it mental accounting: dividing and segregating one's financial resources to dedicate them to different life goals, especially if considered fundamental: the daughter's dowry, money for the grandson's education, retirement. A form of artisanal financial planning, but effective nonetheless. However, today, there is a tendency to favor liquidity, often even in the form of "do it yourself": you buy a financial instrument and sell it with a click (a terrible tendency). Restriction can lead to better investment discipline and greater rationality over time (e.g., less panic selling).

If the restriction has value, what solutions can create it more or less effectively?

In this regard, we can distinguish two schemes:

• Legal-Contractual Restriction: This includes pension products (although there are some cases where part of the money in the plan can be liquidated, the sums are tied to meeting the legal requirements. This greatly shifts the focus of investors: many of them rarely look at their pension fund's performance in the first and terrible half of the year. Even better if the pension product is opened for children/grandchildren at a young age), PIR (other instruments that legally impose a restriction, albeit in a softer way: sellable at any time but at the cost of losing tax benefits if sold before the 5-year term), and illiquid funds (solutions that contractually, and sometimes necessarily, impose a restriction: investing in non-listed assets, insurance products that provide initial lock-up periods for the sums paid, up to more significant investments in specific projects "club deals" or forms of venture capital. It's also worth noting that real estate traditionally imposes a non-short-term restriction);
• Emotional-Behavioral Restriction: Here, the advisor's ability to use the right levers comes into play (unfortunately or fortunately, it is necessary for healthy and proper financial planning and portfolio optimization: emotions often play tricks). For example, a simple PAC (Plan d'Accumulo Capitale or Capital Accumulation Plan) nonetheless creates a restriction/incentive in the client's mind to stay invested, even during crises. Financial planning itself is a suitable solution to create restrictions if the emphasis on the importance of achieving specific goals is adequately placed by the advisor: "You don't want your child not to go to college, do you?", "You don't want to leave your heirs in financial difficulty, do you?".