I was struck recently by a radio ad for an insurance company where the narrator described a situation where a patient went to two different doctors and received two medications. When the patient went to the pharmacist to have the prescriptions filled, he was informed that the combination of drugs could be detrimental to his health.
Unfortunately, far too many people have a similar approach to investing. They hire multiple advisors so as not to keep “all their eggs in one basket”, yet the potentially conflicting recommendations that could be harmful to their financial health go undetected because there is no financial pharmacist to alert the investor to the danger.
This is not to say that diversification is not important – it is critical. The asset allocation of a portfolio determines more than 90% of the returns. Stock selection, market timing and other factors account for the rest in very small proportions. So what’s the problem with having multiple advisors?
First, by employing multiple advisors, an investor loses an economic advantage of having all of their investments combined for fee purposes. Advisors need to get paid for the service they provide which typically is in the form of an advisory fee. The fee is typically a percentage of the portfolio being managed, and often is reduced based on the size of the portfolio. If you have multiple advisors, you are likely paying more in fees, which will drag down the overall return.
Second, think about why you hire an advisor. To get the best return possible? How would you know if you were? Smart investors hire an investment advisor to manage risk. This means having an advisor that can build a customized portfolio that reflects the risk you are willing to take, while achieving long term returns commensurate with an appropriate benchmark. If you have multiple advisors, there is a good possibility that they are not working together. The portfolio construction could be overlapping or conflicting. So who is really managing the risk in your portfolio? You are – and paying handsomely for the privilege.
In years past, when investment advisors were more specialized and technology and investment products were more limited, having multiple advisors made some sense. Today, it is possible to achieve broad diversification using multiple money managers and strategies through a single advisor. The advantage is that you have one person overseeing the entire process, keeping the risk, and the fees, in check.
Often I hear that people hire multiple managers to keep their advisors “honest”. Trust is a key component to any advisory relationship and you should feel confident that your advisor takes the time to know you, understands your needs, and has your best interest at heart. If you don’t feel that way, regardless of the great performance you think you’re getting, it’s time for a new advisor. I also hear that pieces of a portfolio are being managed by friends or family as a favor. I am not against having friends or family as advisors – who better to trust? But if you are not willing to put all your money with them, then it’s better to put nothing. Find another way to find favor.