By Mary A. Malgoire, MBA, CFP™
August, 2007
Prospective clients often ask me, “What’s your track record?” meaning, “What investment returns have your clients achieved?” With the terrible market performance of 2008 fresh in everyone’s mind, the question comes up even more frequently than before.
But it’s not the relevant question. The investment returns question misses the real issue for most people: Are they achieving the financial and personal goals that are important to them? In other words, is the advisor delivering results?
People’s confusion occurs because the many terms used to describe advisory services are jumbled together: investment management, money management, wealth management, comprehensive financial advice, financial planning, financial advisory services, and the like. They might seem to be interchangeable. But they are not. From the investor’s standpoint, a big line in the sand can be drawn between professionals who deliver investment management only and those who provide both investment and financial planning services.
Let me explain.
Let's say the individual has a portfolio consisting of stocks, some brokerage mutual funds (several with back-end loads), a few CDs, a smattering of stock options from her employer, an annuity she picked up along the way, a previous employer's 401K, several large IRAs with individual stocks, and perhaps lots of cash in a checking/savings account at the bank. The accounts are scattered here and there and the tax treatment varies (some are in retirement accounts, some not). This is a typical, real-life set of investments for many savers.
Let's examine what happens for someone who chooses a firm that provides strictly investment management services. From the get-go, she will face a problem because the investment management firm doesn't want to handle the "odd" investments... the CDs, stock options, the old 401K, and the annuity. These positions require additional communication with the client. Updated balance information is not readily available. And executing trades or recommended reallocations cannot be automated. Not including them in the portfolio, however, means that the investment plan is incomplete and not integrated. The investor is still on her own to handle these assets. However, a greater concern is that if these important positions are not taken into account the investor may carry risk that is not adequately offset with investments elsewhere in the portfolio. For example, if the investor's source of income and stock option portfolio is tied up in, say, the technology industry, this risk (a very significant one) must be balanced with non-US, non-technology investments in other parts of the portfolio.
Usually, the next step for the investment management firm is to get the assets deployed into the firm's recommended securities. This generally follows an interview with the client about her circumstances and goals. "Investing up" as it is called, typically means selling all existing positions and buying the recommended investments. Many firms do not pay much attention to the tax consequences or the back-end loads that result from this wholesale turnover in the portfolio. [I watched a bank trust-managed portfolio move a client's investments from the family's low-basis stocks, then to proprietary bank funds, then to individual equities, then back to bank-sponsored mutual funds in the space of about three years due to successive changes in bank ownership. The tax bill was depressing. Fees to the bank were egregious.]
Investing in the firm's recommended securities is understandable since it is widely accepted that the key measure of an investment firm's value to the client is "performance". But is pure "performance" why they were hired? Maybe. But I think the reason investors hire financial advisors is for "results". I'm talking about results that are broader than investment gains. To be sure, investment gains are important, but the additional value of problem solving, financial security, and ultimate life satisfaction, now these are "results"!
Consider the following questions that come to mind when studying a portfolio, like the one above, for a financial planning client:
- How much should be left in operating cash? What are her coming cash needs (a big vacation; a remodel; a tax bill?) What life changes (retirement?) are anticipated that would affect this?
- What investments should be considered part of the portfolio for allocation purposes? The CDs? The stock options? The annuity? Does a concentrated position in the employer's stock preclude certain investments in other parts of the portfolio?
- What is this portfolio costing her each year? What are the embedded fees in the annuity, the old 401K, and the brokerage mutual funds? Can she do anything about that? And what about taxes? Is it possible to create future tax savings? For example by converting a traditional IRA to a Roth IRA.
- What's it been like for her to manage this broad array of investment vehicles? Can she simplify, reducing mail and paperwork? Roll over the old 401K to an IRA? Consolidate the brokerage accounts and funds as well as the IRAs?
- Will she be saving into this portfolio? For how long? If she’s retired, what is a sensible amount to withdraw monthly from the portfolio and not jeopardize long-term financial security? And with a client who is deep into retirement, who are the funds ultimately for? Or, perhaps, how much can be gifted to family/charity without putting security at risk?
- There are more questions at the point when the recommended investment plan is designed. Is there just one portfolio or several? What should go into the tax-deferred and tax-free vehicles, and which should be in taxable accounts? How can she minimize taxes yet achieve the desired allocation? Can she keep the equities and work around them, filling in with others to achieve stability and balance? And what about existing investments that are unattractive because they carry high fees or high back-end loads? What alternatives are there, even if they are less than ideal? Or should she wait to liquidate them until back-end loads have expired?
The pure money management firm shies away from these messy questions because they must compromise their recommendations and thus are unable to measure the impact of their investment advice.
I would venture to say that many of the questions above cannot be answered without robust financial planning projections. This is especially true of the questions that involve taxes and sustainability of the assets. Broader knowledge of the investor’s financial circumstances may also uncover a position in an asset class, such as real estate, that might inadvertently be duplicated in the portfolio designed by the strict "money manager".
For these reasons, when financial planning is involved, no client’s portfolio could possibly look exactly like the next client's. Therefore, "what's your track record?” meaning, "what investment returns have clients achieved" is rarely a relevant question at our firm. When every client's portfolio is unique to their personal situation and circumstances, then questions like, how long have clients been with the firm, and how many clients are still with the firm after 5 or 10 years, are a better measure of results.
Don't get me wrong, investment performance is still an important measure of satisfaction for clients. But, I would argue that for investment management firms it dictates the process of investing and defines success in a way that is not always best for the investor. Many important issues are left on the table — unexplored, unevaluated. And, sometimes exploring these issues lead to big results. For example, helping to determine how much to withdraw for living needs and then making the draws from the taxable portfolio instead of from the IRA made a big difference for one recently-retired new client of ours.
Investors would do well to understand the difference in approach between a money management firm and a comprehensive financial advisory firm. Because of the stock market bubble/crash earlier in the decade, investors are now generally aware of the dangers of focusing on performance alone. However, the benefits of a truly comprehensive investment advisory service still elude most savers. Managing investments in conjunction with financial planning needs and circumstances also renders a performance statistic, but it is one delivered in the context of broader life "results".
