Have Financial Advisors Forgotten How To Manage Money?

Ok, maybe they didn't forget. They just outsource it more and more.

At my previous brokerage firm, one theme I can remember repeated again and again was how important it was to free up time to sell more things to more people. Outsourcing advisor functions was a big part of that.

I fully support running an efficient business, but not when that outsourcing comes at the expense of the very clients who pay me so I can stay in business!

More and more, financial advisors are doing less of the important investment work in an effort to serve more clients and gather more assets.

The mundane yet critically important tasks of selecting appropriate investments, researching how different investments fill out an asset allocation, looking for tax loss harvesting opportunities, and monitoring for rebalancing opportunities are increasingly being taken over by entities other than the advisor the investor hired in the first place!

This presents a problem for clients lured into supposedly sophisticated third party money manager strategies; it's an additional layer of people that want a cut of your returns.

A Quick History

Before I ever even got into this business, when you hired a financial advisor, that advisor directly controlled what was bought and sold inside of your brokerage account on the advisor's employer platform (Merrill, UBS, Wells, etc). Periodically, the advisor would call you to confirm trades or pitch new ideas. When it was time to change tactics, it was the advisor who made this decision. All portfolio adjustments were orchestrated exclusively by the advisor.

The New Model

Why bother with all the important stuff when you can convince your clients it's better to have someone else do it? "Separately Managed Accounts", or SMAs, were the first to offer customized advice in the form handpicked stocks centered around a theme, such as large cap value for example. Think of an SMA as a personal mutual fund that only you own shares in. Back in the 70's, SMAs were reserved for the super wealthy (> $25M), but now if you have ~ $100,000 you can buy in as well.

Over the last decade, brokerage firms have unrolled their own versions of SMAs called "Managed Accounts", also geared towards investors of more modest means. Most of the big advisory firms offer these managed portfolio solutions; where the company is managing a model, usually packed with mutual funds (unfortunately, sometimes too many of their own house brand funds).

UBS has several different strategies to choose from. Merrill Lynch offers the Select managed account. And my old firm, Ameriprise, promotes Active Portfolios & various SMAs, just to name a few examples.

The common theme with any SMA, Managed Account, Unified Managed Account, or any other fancy name a third party manager calls themselves is it's an investment program run by someone other than the financial advisor. The financial advisor is simply a conduit between you and the portfolio manager.

Are The Costs Worth It?

According to NASDAQ, SMA all-in fees range from 1.5% to 2.8% of assets.

Ever hear the saying "fees are only important in the absence of value?". It was a sales trick I was taught, and shamefully used with regularity. It's common for an advisor to pitch a managed account this way. The idea of ultra focused & specialized expertise in a certain area of the market sounds pretty appealing.

That expertise may have in fact rewarded SMA investors. Barron's reports that the average SMA outperformed their mutual fund counterparts by 0.62% for the decade ending Dec, 2010. So it seems at least the SMA style of managed accounts seems to be working in that context. But, let's not forget that the bar in beating most mutual funds isn't that high; the vast majority of mutual funds fail to outperform Their Basic Benchmarks.

So, maybe SMA costs might be worth it, sometimes...

My Issue With Outsourcing Investment Management

Financial advisors desperately want to get paid. If they can keep earning their 1% without doing any of the actual work, it makes for an extremely profitable business model.

Investors need to recognize that the advisory fee a financial advisor charges arrives in addition to the cost of the managed account fee, the expenses of the funds used in the managed account, and the trading costs associated with buying or selling individual stocks and bonds. That can all add up.

Investors don't need to fear paying an advisory fee, but the advisor BETTER BE EARNING IT. They should be conducting research. They should be testing the underlying stocks and bonds (to support a risk appropriate asset allocation) in the funds they recommend. They should be looking for tax loss harvesting opportunities in taxable accounts. They should be monitoring the portfolio for rebalancing opportunities. Last, they should be educating their clients with ongoing communications specific to their portfolios.

It's a slap in the face when someone other than your advisor is doing all that, yet the advisor is still collecting their percentage fee as if it were them that deserves the credit! I see this all the time when a new client shows me their statements.

By the way, I do all of the things I just mentioned to earn my advisory fee. Just in case you were wondering.

What You Should Do

It can be very difficult to identify on your statement if your advisor is actually doing the work. Multiple accounts for the same goal, a single account filled only with individual stocks, or statements from more than one provider are all tell-tale signs you're probably enrolled in some type of outsourced investment arrangement.

The best thing you can do is ask! Make your advisor prove their worth. If they aren't doing everything I just listed (a minimum standard), then they don't deserve what I know you're paying them.

When pressed, if you ever receive an answer that goes something like "through a disciplined process, I systematically screen for top managers and align you with the best strategies based on your risk profile", it's a bunch of garbage. It's called "fluff", and it isn't worth squat.

To put it in perspective, if you had $500,000 and your advisor recommended outsourcing, would you still pay the advisor $5,000 annually (the 1% they're probably charging)? That would be insane, but it's more common than you think.

I'm all for aligning investors with the most appropriate managers, but if literally that's all I'm doing, it's worth maybe $500. That's it! There is absolutely no valid rationale a financial advisor should be charging a percentage of your assets if all they're doing is picking someone else to pull the portfolio strings.