Is a customized investment portfolio a bad idea?
How does your advisor pick which clients receives the first phone call when the next 2008 happens?
Does customization lead to inequality?
Whether it be clothing, jewelry or homes, customization can transform the mundane into something truly extraordinary. Similarly, many investment advisors market themselves as builders of custom portfolio solutions. Is this realistic? Is then even desirable?
Although a custom portfolio may seem like the premium option, we feel the idea is problematic for a few reasons:
Problem 1 – Does your advisor have the time to properly understand the investments they are managing?
The investment universe is vast; there are over 10,000 mutual funds alone to pick from in Canada. Add stocks, exchange traded funds, bonds, segregated funds, hedge funds, and other kinds of public/private investments to the mix and narrowing down the investment universe becomes even more challenging.
Advisor claiming to build custom portfolios for clients will often have 500 or more different investments throughout their practice. I can say from experience that no amount of technology will allow you to gain a detailed enough insight into that many investments. Truly understanding the investments, you recommended to clients takes a great amount of upfront and ongoing due diligence. There is no such thing as set-it-and-forget-it in the world of investing.
Add to this the daily demands on your advisors time such as client meetings, responding to emails, making trades, building client plans, marketing, staffing, etc and it becomes clear that having a unique investment portfolio probably means that you have a portfolio that no one is watchingclosely enough.
Problem 2 – Does your advisor have the ability to be nimble?
The average Canadian investment advisor works with 200 to 300 families or roughly 500-800 people when you count spouses and other family members in a household. If the advisor customizes portfolios for each household, they end up managing hundreds of portfolios, with hundreds or even thousands of investments.
Imagine that new economic data has come out that changes the way your advisor feels about the prospects for growth and they have decided to increase the allocation to fixed-income (bonds) to protect their clients. How much time will it take for them to create a custom rebalancing for each client?
First an advisor’s team would have to spend time calculating the exact amount of each investment to buy or sell and from which accounts (including the tax implications of certain trades). Then a phone call or meeting has to occur to explain the recommendations, discuss suitability and obtain authorization to proceed with the trades. Detailed meeting notes have to be written. The advisor’s team will then make and diarize the trades. They then check the trades the following day to ensure proper execution and settlement. Lastly, the team will reach out to the clients to confirm completion.
Therefore, the rebalancing of a single household’s portfolio will easily take 2-3 hours of an advisor’s time. Now multiply this time commitment by 200-300 families and you can see that it would take weeks if not months for most advisors to rebalance all the accounts in their practice.
Problem 3 – Does customization lead to inequality?
How does your advisor pick which clients receives the first phone call when the next 2008 happens? The reality is, your advisor will probably call their largest clients first.
Here’s a blunt question: Is your retirement nest egg any less valuable just because you’re not your advisor’s largest client? Of course not, but unfortunately most Canadians not working with a Portfolio Manager face this dilemma.
The Answer: Discretionary investment management with model portfolios.
We’ve been pointing out some of the limitations that advisors face in managing a diverse client base. These limitations should be most concerning to retirees because they are the most at risk of being negatively impacted by volatility in their investment portfolio. What’s the solution?
Solution 1 – Closely track a smaller number of investments.
It is far better if your advisor has a disciplined process for screening and selecting a reasonable number of high-quality investments to act as the building blocks of their various model portfolios. This allows them to gain a deeper understanding of each holding and to know when to hold and when to replace it with a more attractive offering.
Solution 2 – Being nimble.
Less than 5% of investment advisors in Canada are Portfolio Managers. Portfolio Managers are fiduciaries who must meet the highest conditions of registration with the securities commissions and are held to a very strict code of conduct.
A Portfolio Manager using model portfolios will have both the client authorization and the software to allow them to make changes to all client accounts simultaneously allowing an entire practice to be rebalanced in 30-60 minutes versus weeks or even months.
Solution 3 – Treating all clients equally.
Since Portfolio Manager rebalance all clients in a model at the same time it alleviates the concern that larger clients might be receiving special treatment. Portfolio Managers are held to a higher legal standard than investment advisors and are viewed as having a fiduciary duty to act in the best interest of the clients. From a trading perspective this means we cannot be placing the interest of some clients above others and thus have to rebalance all clients together.
We don’t manage 300 retirement portfolios. Instead, we manage one retirement income model, which most of our retiree’s hold. When we rebalance the model, the changes occur simultaneously in all of our clients’ accounts.
Think of a large city where commuters are going downtown to work every day. The commuters all have a similar need; transportation to get to and from work every day. The reasons they go to work, the types of jobs they occupy, their hobbies and interests are all different and unique. But the transportation need is the same, so they can all occupy the same bus together and get to where they need to go.
We believe that customization belongs in the planning relationship with your financial planner, which is driven by the unique circumstances of you and your family’s needs and goals. It does not belong in your retirement portfolio.
Please do not hesitate to call or email us with any further questions.
This information has been prepared by Lorenzo Pederzani, CFA, CFP®, CIM® who is the Chief Executive Officer (CEO) and a Portfolio Manager for Westmount Wealth Management Inc. and an Insurance Advisor for Westmount Wealth Planning Inc. Westmount Wealth Management Inc. is registered as a Portfolio Manager in British Columbia, Alberta, and Ontario. Westmount Wealth Planning Inc. is a subsidiary of Westmount Wealth Management Inc.
