Jane and Joe head in to see their financial advisor to invest some money. They hope that the advisor has the edge to find the best investments so they can get to financial freedom that much quicker. They sit down with their investment advisor and the advisor says that something like this, “Hi Jane and Joe, I believe investing is personal. Every investor is unique so before I can recommend a portfolio, I need to learn a little more about you. I need to understand your risk tolerance, your financial knowledge, your time horizons and the more I understand, the easier it will be for me to recommend a portfolio that is customized for your needs.”
Does this story sound familiar to you? If so, the next step might also hit home. The advisor pulls out a questionnaire for Jane and Joe to fill out to find out what kind of portfolio to recommend. In fact, the results of the questionnaire will lump Jane and Joe into one of five categories: Conservative, Income, Balanced, Growth and Aggressive growth. Chances are Jane and Joe will then invest in a managed portfolio of predetermined funds that allocates assets to maximize return and reduce risk in their category. Every company has some version of these managed programs.
The good and the bad
The good news is that these managed programs use the science of asset allocation and modern portfolio theory to determine the most efficient mix of assets.
On the other hand, most managed portfolios are all starting to look the same. Although all investors are unique, these programs are not truly treating individuals that way. Instead, investors are being lumped into one of five investment categories and being treated like all other investors in that category.
You might think shopping around to different companies might help you find an edge but most of these programs are more similar than different. In fact, when I looked at the allocation of assets within 12 different programs, they were all strikingly similar in their allocation of stocks, bonds and cash.
Driven by regulations
If you are in one of these programs, don’t necessarily blame your advisor or even the financial institution. It’s become the norm because the regulators have instituted some detailed processes including some cheques and balances that advisors must go through to ensure that portfolios are suitable for their clients.
The whole point of regulatory process is to prevent a small number of bad advisors from recommending inappropriate investments to their clients. An extreme example would be preventing an advisor from selling a high risk speculative, sophisticated investment to a conservative 75 year old investor looking for guaranteed income. Although I understand the logic of protecting the investor, this investment process leads me to believe that all investing is starting to look the same. I see it day in and day out with investors. For the most part, I see very little differentiation out there.
What’s my point?
For most investors, we are traveling in the same boat. When markets are down and the waters are rocky, it seems all our portfolios are down and we all ride through the volatility. When markets are up and the waters seem calm, we all seem to reap the rewards.
When it comes to investing, investors and advisors are all looking for the edge with unique philosophies, strategies and products. Unfortunately, this is pretty hard to find. When someone tells you they have the edge in investing, chances are they are working within the same regulatory environment as all other advisors and financial institutions. So be careful of being lured by messages that sound too good to be true especially if the recommendation is a managed portfolio. Managed portfolios might have substance behind them but they sure aren’t unique.