In investing, size matters. Account size, that is.
Financial advisors have long grappled with how to properly invest smaller accounts.
These small-but-mighty portfolios can come from many sources. A high-net-worth client may have a small individual retirement account or 401(k) rollover in addition to their larger holdings. Or the child or grandchild of a valued client may approach you asking for help with a more modest investment portfolio.
Ultimately, tackling these accounts is no different than any other fiduciary decision you make: You are deciding what is best for the client. And that best path may differ from client to client.
Many advisors want every client to benefit from their most thought-out advice. But it may not make sense to deliver an identical investment strategy to accounts of, say, $50,000 or $100,000 and to accounts 10 times that size.
After all, owning 30 to 50 securities in a $500,000 account looks reasonable. But squeezing that same allocation into an account of $25,000 might not be the client’s idea of efficiency. The last thing you want to do is discriminate based on account size. But your hands are tied to some extent. Or are they?
Some advisors now find the direct indexing concept appealing as a solution. This structure uses advanced trading technology to take an investment index or model portfolio provided by a money manager and convert it into a more custom version of that model at the client level.
However, those in the exchange-traded-fund business and others may argue that the direct index method is like taking a big, juicy hamburger served at a high-end restaurant and chopping it up into tiny pieces. After all, advisors are allocating assets, not splitting the atom here. Perhaps you can take a less surgical approach to solving the “small account problem.”
Here’s how advisors should tackle, and profit from, small accounts.
Use ETFs Instead of Individual Stocks or Bonds
Using ETFs keeps the communication simple while allowing you to educate the asset owners in a way that inspires confidence.
If you believe that, to a large extent, “stock-picking is for show, and asset allocation is for dough,” this would appeal to you.
Establish 4 ETF Slots to Fill the Portfolio
To fill your small accounts with appropriate but manageable holdings, consider breaking them into four slots, each filled by one ETF. Every slot addresses one segment of the portfolio.
Here’s how you might structure your four-ETF portfolio:
— Core equity position. Consider this what you would own instead of a full portfolio of stocks. For example, you can choose an ETF that owns a set of large-cap stocks that resembles the type of equity portfolio you would put together if you were choosing the stocks yourself or if you had your favorite third-party manager doing it. This is likely the largest position of the four ETFs in the mix. But you can tailor the mix to the client’s investment objectives and risk tolerance.
— Hedge position. Today’s ETF market includes a wide variety of ways to hedge equity portfolios. There are ETFs that move directly opposite the major stock market indexes, as well as funds that use options, long-short or arbitrage techniques. Short-term, high-quality bonds may be a consideration, depending on your attitude toward bonds in this climate.
— Tactical position. This position is bought with the intention of pursuing gains for weeks or months, not years, as might be the case with that core equity portfolio. Having this in your four-ETF portfolio allows you do two things: capitalize on the increasing tactical nature of market moves, particularly in stock market segments and sectors, and signal that you are able to act when there is money to be made or a major loss to be prevented.
— Wild-card position. This could be a second equity position or something that is uncorrelated with stocks and bonds, such as something commodity-related or a unique sector. It could also be another wild-card position. If you’re not into it, you can skip this segment entirely.
Take a Modern Asset Allocation Approach
Don’t forget to confront the reality of low interest rates.
Specifically, don’t consider bonds to be a long-term-hold asset class in these portfolios. After all, high-quality bonds may earn your client a return lower than your asset-based fee.
Rates are low, and unless they fall to and through 0%, bond investing may become unprofitable. Instead, consider bond ETFs, but do not force them to always be included in the four-ETF portfolio mix.
Mix Offensive and Defensive Positions
This strategy aims to respond to near all-time highs in the equity market.
You have four ETF slots to work with. And while equities can still be the “core” of the portfolio mix, today’s markets demand that advisors give serious thought to what can happen at this precarious point in the cycle for stocks and bonds alike.
This is just a conceptual outline. The allocation between the ETFs and the degree to which you are active versus passive are where you have to consider your own abilities and desire to manage these assets. Additionally, consider what your clients want and need.
Using this base approach as a starting point, you can customize the portfolio strategy, security selection, ETF rotation signals (when and why portfolio changes are made) and how you communicate the value of your approach to your clients. After all, there’s no reason great things can’t come in small packages.
Turn a Profit From These Small Accounts
By having a small-account strategy and treating it as an asset in your practice, you and your clients win.
They get your best thinking applied to all of their accounts. Make no mistake about it, your clients value these accounts, too. And if you develop an efficient, strategic approach to managing these, including some active management, they will know they are getting value out of every part of their relationship with you.
When they realize you are not overlooking anything simply because you are not getting paid a lot on smaller accounts, it shines a bright light on everything else you do. That makes this effort a goodwill profit center in your business.
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