Many of you reading this article today have more than one financial advisor. In fact, many of you have more than two financial advisors, plus a 401k for which you may receive no input from either of your one, two or three advisors. This can create inherent problems and conflicts. This article will discuss the implications of utilizing more than one financial advisor, both on the upside and on the downside (but mostly on the downside) and the very real effects this can have on your financial well being.
Our feeling is that is has something to do with "What if I've chosen poorly and my investments under-perform their benchmark indexes?" Or, "What if I've chosen poorly and my advisor is, simply put, providing advice, but only poor advice!?" Many investors see it as highly risky to utilize the services of only one advisor. If you should diversify investments, shouldn't you also diversify with respect to advisors? After all, we've always been told to "never put all your eggs in one basket." While this argument does hold some validity we would tend argue against it for a variety of reasons.
Something many investors miss by using more than one financial advisor (and some miss even when using a single financial advisor) is having their level of required return quantified after they provide the advisor information including but not limited to; optimal retirement age, required retirement income, their current annual savings amount, the amount and location of their current investment portfolio, and so on and so on. Using all obtained information the advisor should then determine the level of return and the subsequent level of risk (managed, of course, through the use of non-correlated assets) appropriate to meet retirement goals. This can be accomplished by using financial planning software AND Monte Carlo analysis, but that is yet another article.
For more information on correlation please see the series of articles titled "Putting Risk in Its Place in Your Portfolio": Parts 1, 2, and 3 under the Risk Management section of this website.
If the investor is not comfortable accepting the degree of risk required to meet their goals, then goals need to be modified and the scenarios rerun; or if the investor is comfortable taking more risk associated with investments that have the potential for a higher rate of return than is required if it means the potential for a higher retirement income, the scenario needs to be rerun utilizing new assumptions. It's somewhat of an iterative process and a process that needs to be rerun at least once a year taking into consideration all of the new facts and figures that have occurred over the past year. As is obvious, it would be extremely difficult for two financial advisors to collaborate on this process and coordinate their portfolios to seek the desired level of return.
A commonly overlooked area in the assembly of a portfolio is tax efficiency; after all, not only is asset allocation important, but so is asset location.
What does asset location mean? The asset location indicates in what type of account the investment is held. For example, IRAs grow tax deferred and typically (depending on your advisor) offer almost unlimited investment options; 401ks also grow tax deferred, but have more limited investment options; personal accounts, on the other hand, are fully taxable and should have almost unlimited investment options. Thus both the type and the location of the investment are critical when it comes to taxes.
For example, for someone who doesn't need the income (is still in the accumulation phase), it makes sense to hold Real Estate Investment Trusts ("REITs", whose dividends are taxed as ordinary income), traditional bonds, Treasury Inflation Protected Securities ("TIPS") and high turnover stock portfolios in tax deferred accounts. Not only that, but the limited investment options available in 401ks must be taken into account, making the decisions a bit more complex (raising the question of tax efficiency versus sub optimal investment options in these type of accounts). This, of course, ties closely to asset allocation. If you are retired or nearing retirement, yet another level of complexity is added, as withdrawals must be taken into account (including Required Minimum Distributions from Traditional IRAs). At this point you not only have to decide where and how much to hold in certain types of investments, but also which accounts should be sold and in what amounts so that your marginal tax bracket is held down every year (and you're not bouncing from high to low tax brackets each year, which can create extra taxes for you). As you can see, it would be extremely difficult for two let alone three advisors to work together under all of these constraints; yet, if they are to do they are to perform their jobs to the best of their abilities, this is what they must do.Finally; Asset Allocation, Risk and Performance
Now the area in which many of you are the most interested, returns. For many investors, this is their primary reason for choosing a certain financial advisor. However, if you choose more than one advisor based on this criteria, you may be creating more risk than is necessary. This is due to the idea that even if all of your accounts held with a single advisor are working in harmony, unless there is a high level of communication, the advisors themselves are not working in harmony. This can lead to portfolio overlap (which may create unnecessary risk) as well as a sub optimal overall asset allocation. All of this relates back to correlation and how risk should not be viewed simply from a stand alone view (i.e. looking at risk as measured by the standard deviation of a single possible investment on a stand alone basis), but from the view of how does adding that investment in different amounts affect the risk of your whole portfolio? The odd thing about correlation is that by choosing an asset that has a very low correlation to your current total portfolio is that the portfolio's risk may be lowered by adding the asset even if the asset is (on a stand alone basis) riskier than the portfolio. Intuitively this is very hard for many investors to grasp, but is a mathematical fact. Additionally, tax efficiency which we previously discussed can also have a large impact on your portfolio's returns.
Tying all of this together, the ultimate issue comes down to whether or not an advisor can make decisions in a vacuum (which they certainly can) and are those decisions what is ultimately in your best interest? What we mean by "in a vacuum" is can the advisor make optimal stand alone decisions without having knowledge of your entire financial life? An example would be seeing an advisor and saying "Would you help me allocate this IRA?" Our answer is a very distinct, NO, the advisor cannot produce allocations that are in your best interest without gathering much, much more information. After all, every financial decision you or your advisor makes impacts another part of your financial life. Ultimately, there is no such thing as an optimal stand alone decision. If you are willing to accept these implications and convey that to the advisor in question, the advisor should caution you against such decisions. The decision, however, is yours alone to make.
As for the benefits of utilizing more than one advisor, we can think of none IF you've done your homework on the advisor you are utilizing. The questions you should ask your advisor before hiring them should be comprehensive in nature and should (along with referrals, etc.) give you confidence in their ability. This is a topic for an entirely different article however. Our opinion is that if you are not comfortable with them being your sole advisor, they probably shouldn't be one of two or three advisors either.
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