So, What Do I Get For the 1%?

The way an advisor charges a client has been rehashed many times on a number of different blogs, so I won’t get too far into explaining each and every option. Recently, there have been some advisors bucking the norm. The norm for advisors has been to charge a percentage of assets under management. Some advisors have bucked this trend and have been charging a flat fee no matter how much an individual has under management. There have been some recent blog posts about why charging a percentage of assets under management is not in the best interests of the client. I agree and disagree to a certain extent.

In my mind to charge a fee based on assets under management aligns an advisor’s interest with the client’s interest. If the portfolio appreciates, the advisor gets a raise. If the portfolio depreciates, the advisor gets a pay cut. Pretty simple, right? Well, I believe the more difficult issue comes about when you look at what each client is receiving for the percentage they are paying for the management of their assets.

Let’s take an example. Mr. Smith pays his advisor 1 percent to manage his $500,000 portfolio, so he pays $5,000 per year for the services. So, what is Mr. Smith receiving for $5,000 he pays his advisor? Mr. Smith is receiving a portfolio of mutual funds that the advisor has researched and chosen and thus outsourced the management of the portfolio to these funds. So, for $5,000 Mr. Smith is paying his advisor $5,000 to be a manager of managers, be invited to play golf, and receive a call a couple times a year to stay in touch. This scenario plays out over and over again in the wealth management business. So, for the most part I agree with the argument that an advisor should be providing more for the fee he/she is charging their client.

Some firms have been incorporating financial planning into their pricing model, which provides a great value to many clients that are looking for that service. Financial planning can get very expensive and to provide that service as part of the management fee is a great value in my opinion. On the other hand, my firm provides a different service because my firm targets a very specific demographic: business owners and entrepreneurs. Financial planning is not the most important service that they are interested in being provided. We wear many hats for our clients. We can and should be thought of as investment managers, business consultants, tax strategists, and estate planners. These are the services that are most important to our clients. We provide value over and above just managing our client’s money. Our clients need someone to answer questions and provide relevant answers that relate to their business and effect their personal life. Some frequently asked questions are; What accounts should we open and fund to save on taxes? Who can you introduce us to that would benefit our business?  How should we structure our business going forward?  What assets should be held in trust as we become more successful? Can you review an investor deck and give me your opinion? Etc.

These are the questions we get asked and these are the questions we are prepared to answer. We try to provide the very best guidance for our clients. We work with our clients throughout their personal and professional lives. We are successful if they are successful. Providing our clients with these ancillary services allows us to be part of their team. If our clients were to go out and hire a firm to answer these questions or to help them to strategize, the out of pocket costs would be prohibitive for most and time consuming to find the right fit. We not only provide our clients the benefit of using our resources and capabilities to build their businesses, but we help them to cut the fat and simplify their personal and professional teams.

If you’re considering working with an advisor make sure you ask the question of, “what services are you providing for the fee that I’m paying.” If it doesn’t add up or if the ancillary services don’t fit with your needs, move on. There are some great firms our there that will fit your requirements, it just takes a little digging. Fees aren’t everything when you pick an advisor, but they are certainly a big factor when considering what you receive in return for the fee you pay. So, do your due diligence. There’s someone for everyone.

Skeptical of Robo-Advisors? You Should Be…

I’m an information hog. I love to read about the new technologies breaching the financial services industry. In fact, I usually request a demo of financial software if I think it’s unique. I have requested demo’s from JemStep, Schwab Intelligent Portfolios, FutureAdvisor, Motif Investing, Betterment, and so on. I wanted to understand how their software works and how portfolios are constructed. Many times the individuals that I spoke with couldn’t give me a very good answer as to how they construct their portfolios besides providing me with a blanket answer of diversification. Many state that their investment philosophies are backed by big names like Burton Malkiel, but fail to give me an understanding of how portfolios are chosen or how risk is measured. As a result, I made the decision to not provide a Robo option to prospective clients of my firm, but that may change.

Yesterday, I received an email from a small Robo-Advisor/Risk Assessment firm named RiXtrema. RiXtrema came out with a robo-advisor for advisors called BioniX. It looks at risk in a much more reliable manner. For instance, take this excerpt from the RiXtrema White Paper, which I highly suggest you read if your money is invested with a Robo-advisor.

“Robo-advisor methodologies are based on mean-variance optimization, which focuses on trailing variance as a measure of risk. Trailing variance is calculated from relatively recent history of the financial markets, usually a few years. Variance in financial models is simply an average squared difference between the average return and return on every date observed over some historic period of time. Thus it should be clear that when [the] market is trending up like we have seen over the past few years, the average return is positive and deviations from that average are relatively small. That is why in periods of prolonged market tranquility, trailing risk measures have dramatically understated market risk.”

Not to make things technical, but if you have some sense of what that statement means, it should give you pause with the current volatility in the market. The majority of Robo-Advisors will manage risk in this way. To follow up with another great excerpt from the white paper:

“In addition to the problem of understatement of risk prior to a crisis, variance based measures overstate risk following it. You can see that risk in our chart keeps climbing all through 2009 and, in fact, keeps climbing through 2011. As a result, investors that go to robos after the crisis will get portfolios that are now excessively light on stocks. Mean variance algorithms can be thought of as ‘buy high sell low’ strategies around crisis events, which is the opposite of what investors want. Imagine if an advisor had suggested that clients load up on risky assets prior to the Lehman collapse, but then after the collapse in 2009 started putting everyone in bonds. That would be precisely what should not happen, but that is what existing robo technologies are set to do. It is no surprise that the Fed no longer uses Value-at-Risk (essentially same as trailing variance) when talking about systemic risk, but focuses exclusively on stress testing.”

So, you’re telling me Robo’s will buy high and sell low? Yes, that’s what it’s saying. Think of it as measuring risk on a delay. It’s like getting delayed quotes when you’re trying to trade intraday. It’s worthless and you lose money. Why would you do it? My point is that if you decide to use an automated investment platform make sure you understand how they measure risk and how it constructs portfolios based on that risk. For the past 2 years, Wealthfront portfolios have gotten murdered. Wealthfront portfolios have no Treasuries. There’s nothing in the portfolios to soften the blow. Their portfolios have stunk the place up! A person with average risk tolerance still has 38% of their portfolio in foreign plus emerging stocks or bonds. I don’t know if you noticed, but it’s been quite the shit show in Emerging Market bonds and stocks.

Stay safe and do your homework. I’ll update this post once I demo RiXtrema.

The Archaic Mess That I Left Behind

As I have written about in a previous post, I left a large wire house and started my own wealth management firm fifteen months ago. It was the best decision that I could have made. I saw the writing on the wall very early on. I kept telling myself that the wire house (Wire House = Morgan Stanley, JP Morgan, Wells Fargo, Goldman Sachs, etc.) way of doing business was broken and I truly believed that. I kept thinking to myself, why are all these financial advisors staying at a wire house? Sooner or later it’s going to end in a bloodbath. How many advisors can skip from wire house to wire house chasing large sums of money. The wire houses were losing advisors to the independent channel and they weren’t doing anything about it. It’s as if they thought that they were invicible. Really? Everything the wire house created was to make money for the wire house, not the client. Let me back up by saying that not all advisors act on their own self-interests, but there are many that do. I came in to the financial services industry after practicing law for years. I couldn’t believe the conflict of interest that stared you in the face each and every day, and the wire house was ok with that! In the legal field, if there was a conflict of interest with a client, it’s mandatory that you step down as the attorney. No if, ands, or buts. You MUST step down. If you don’t, you risk losing your license to practice law. As an attorney your license depends on acting in the best interests of your client. Lawyers have ethical standards that are VERY high. Even though I stopped practicing law, I still had to abide by legal ethical standards when I acted as a fiduciary in the financial field.  I even had a higher standard than all other fee-only advisors. Working at a wire house and doing business in that way made me extremely uncomfortable and created risks that I did not want to take. If I wanted to stay in this field, keep my client’s interests #1, and build a business that I was proud of I had to move in a different direction. That’s when I knew I had to go independent and become a fee-only advisor. I’m very proud of what I have created and look forward to each day.

I say all of this because there was a letter written by a wire house advisor that was very telling. In it he mentions:  “The wire houses can not grow their market share in the retail investment market. Stagnant at best and at worst contracting, the situation calls for objective, fresh thinking. Stagnation has led to a system of organized bribes amongst wire houses just to keep their most desirable producers and to attract the most desirable producers from competitors. A truce has been called on litigating these brokers’ departures complete with their customer lists, which in part has led the bribe bidding up higher and higher to unprofitable levels. The current system of paying bribes will hasten the decline of the wire houses.”

To read the entire letter, which I recommend, Click HERE.