Investor: You Have Three Choices…

If you read my post about Looking In The Mirror from a few days ago, you know that I’m fairly jaded about the value that most investment firms can add for the average investor, especially investors still brainwashed into thinking the value of the investment adviser is solely to beat the market.

The intent of the post was definitely not a knock on the financial planning process or the value of having an investment professional in your life, rather it was a commentary about how myopic the pursuit of the perceived value has become. It was also a commentary about the legacy wirehouse firms of Wall Street. They are no longer the place most (if not all) investors should be using, because of the inherent conflicts of interest laden in their business model: A product distribution model in adviser’s clothing. The post was really about a call for common sense & simple reflection.

That being said, without any real call to action all you’re left to do is meditate, which, while useful, doesn’t exactly pay the bills.

Now, there are thousands of vehicles & strategies to try to accomplish anything you could possibly want under the sun. Wall Street’s appetite to sell you anything is insatiable. I mean if brokers are busy schlocking Emerging Market Debt Funds to yield-hungry grandmothers, there’s officially nothing sacred. We all remember the Enron traders, don’t we?

So what do you do?

First off, at it’s most basic level if you are investing, there are really only three levels of expectations you should probably have for your money:

  • Alpha – trying to kill it with market beating returns — You’re focusing on return.
  • AlphaBeta – saving it from collapse or actively mitigating mood swings — You’re focusing on risk.
  • Beta – betting the world isn’t going to end & keeping it lean on fees — You’re focusing on being the market.

All of them in some mixture probably belong in your portfolio. All of them will have limitations. That’s the most important thing to remember about picking any strategy or investment guru to manage your money — the limitations.

Value investing is not the holy grail, it’s simply one-half of the coin. Small caps aren’t going to save your large portfolio. Momentum is not the chalice of champions.  Dividend investing doesn’t always pay. Risk parity isn’t perfectly plucky at pulling rabbits from a hat. And doing nothing but buying and holding isn’t going to be the second coming for couch potatoes providing rock hard portfolios for future spending.

Once you break the investing world down into these three basic elements, it becomes a much smaller place. And if you use these three basic elements as your compass, I think you’ll have a much more clear reason for why you are investing in the strategy you’re considering.

And yet somewhere along the way, you’ve been sold on the notion that your broker and their firm should get paid to manage all of it trying to beat the market, without any sort of look at the limitations…

Without any expectation on the limitations of their business model…

Without any expectation of the limitations of reality…

So, let this serve as your wake up call. The world is a very small place, with very few real choices, and very few opportunities for you to be part of the 1%. Once you accept this, your life will be simpler.

Once you do, you’re 99% of the way to nirvana; with limitations.


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4 thoughts on “Investor: You Have Three Choices…

  1. Pingback: Friday links: few real choices | Abnormal Returns

  2. Pingback: Weekend reading: Other people’s earnings revealed

  3. Edward F Hutton

    Great post. As an advisor ( loose use of term ), at a wirehouse (bank), I agree with all of the above. Over the years I have three distinct moments when I have changed gears in how I advise clients. About ten years ago, I went to a fee only platform. I then went from managing portfolios of stocks and bonds to just broad base ETF’s and a few years ago I implemented Meb Faber’s risk controls of not owning asset classes if they trade below their 200 day moving average at month end.

    As I talk to clients now about their 2011 returns, I realize how ridiculous it is to take to clients in terms of, “you did well last year – we beat the S&P 500.” What a crazy way to frame a conversation with a client about their portfolios. As if beating or underperforming the market is all that is important? As if the only reason you have hired me is to beat the market?

    So now I pondering my fourth gear, truly advising and not playing the role of portfolio manager? I am an advisor and an allocator. We can now buy really cheap beta to get us market returns ( VTI and BND ). My role as I see it is to weight these allocations and fill in with other asset classes to achieve what objectives the client needs.

    The wirehouse/bank model is dead and any advisor who doesn’t see that should start selling off their book now.

    The challenge is how to wean your clients off the idea of “beating the market” and paying you for advice. Thoughts?

  4. Scott Bell Post author

    This is probably one of the biggest hurdles facing the value proposition of the advisor model. For years, billions of Wall Street marketing dollars have been poured down the gullets of investors with the promise of market beating returns. That’s not going to change overnight.

    In general, when I meet with clients we discuss their financial needs/plans and I try (operative word “try”) to build a portfolio that will fit their risk profile and give them the returns they NEED (vs. want) over the long haul, but it’s tough. Hypothetically — I have a client who “needs” 6% a year over the long haul — when the market is up almost 10% in three months he’s made he’s up only 4.5% he’s pissed. I truly believe one of the best investments RIA firms can make is a partnership with a psychologist specializing in money issues, because personally I think an advisor can only talk people off their lizard brain ledge so many times before they’re exhausted — at least that’s the case for me. In general, it’s about managing expectations upfront so they’re not disappointed when the inevitable happens. Having the “three choices” conversation has been a good way for me to frame that conversation.

    Thanks for reading!

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