A buffet sounds great until you have to decide what to actually put on your plate.
The same goes for investing: Endless options sound terrific until you have to decide what to buy for your portfolio. Winnowing down the options from all-you-can-eat to a menu of complementary choices is a proven strategy for designing a portfolio that meets your goals.
Financial advisors have a universe of investing options for their clients; Russell Investments, an institutional investment firm, estimates that the typical advisor tries to track 200 to 300 investments on behalf of clients.
Advisors need to streamline their offerings, according to Russell, so they can offer each client an even more curated slate.
“Too much choice can be paralyzing,” says Scott Couto, president of Fidelity Financial Advisor Solutions, based in Boston. Advisors might be besieged with investment opportunities, but they also have more powerful research tools than those available to consumers.
Still, an advisor’s first step in deciding which investments to recommend to you is rooted in real life, not the digital world. “We haven’t got to the point yet where a computer can show empathy,” Couto says.
He and other practice management experts say basic questions about your financial goals, station in life, expected expenses, anticipated lifestyle and other factors create broad filters that help the advisor narrow the range of potential appropriate investments.
What should be on the menu? Once the advisor has prioritized your investing goals, Couto recommends sorting by type of asset (equities, bonds, alternative investments and so on), and then creating a narrow spectrum of options within each. Each spectrum might include variations on risk, income, liquidity and time horizon, Couto says. “That gets to the concept of relevant choice,” he says, with the options being different shades of the right solution for that equity class.
Recently, for instance, Stephen Provost III, an Evansville, Indiana, senior vice president and financial consultant with advisory firm Hilliard Lyon, worked with a client who had snapped to attention as he neared retirement.
The client wanted to be able to closely estimate how much income he would reap monthly from his investments — what Provost calls “income visibility.” The client also wanted to devote a major slice of his portfolio to investments with guaranteed growth that would offset inflation.
Taking other financial and lifestyle factors into account, Provost chose several options for each of those two major goals. The client chose three complementary equity funds for about 43 percent of his portfolio, with the understanding that the funds were designed both to grow and throw off net income of about 3.4 percent.
Another 43 percent of the portfolio went into zero-coupon Treasury bonds. “That mitigated the downside risk,” Provost says. The rest of the money was split between cash to have available for opportunistic buys and an actively managed fund designed to convert to cash if the fund manager thought that would protect his investors from losses.
Be clear upfront about your financial priorities, because those priorities will guide your advisor as he assembles your menu of options. Your priorities will be translated to investment parameters, and your advisor will come back to you saying, “based on these parameters, this is the risk model,” and other key filters, says Vince DiLeva, senior partner with Signature Estate & Investment Advisors LLC, based in Century City, California.
Ask how each curated slate of investments is tailored for the type of account that will house it, especially if you have tax-deferred accounts, DiLeva recommends. Provost points out that you might need two mini-menus of options: one for accounts that have tax advantages and another for accounts that do not have tax advantages.
“Be sure to ask about [the advisor’s expenses] and why you bought particular investments,” he adds.
At this point, you should dig into the fine print to find out which, if any, of these involve disclosures about fees paid by the fund company to the advisor in exchange for recommending the fund. This type of “shareholder services fee” is supposed to be disclosed on Part 2 of Form ADV, required by the Securities and Exchange Commission.
Form ADV is the disclosure — i.e., the fine print — that outlines all fees involved in investments you buy. Look carefully at this form, especially if you are not sure if your advisor is a fiduciary. If you discover that the advisor has received a fee from the fund company, you will need to factor that in as you negotiate fees so you do not pay to buy into a fund that officially does not charge fees.
Before you bite, be sure you understand both the menu of investments and how they work together to achieve your goals, DiLeva says. “It’s the job of the advisor to help [clients] understand the investments,” he says. “The more you understand, the more comfortable you are with the process.”
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