July 15th, 2013
I bought my first stock with gift money and money saved from summer jobs when I was in high school in the hopes of trying to make some extra spending money. So, obviously, I looked only for stocks that I thought, based on their charts, would appreciate fairly quickly. When I was lucky enough to buy one that did appreciate 20-40% in short order I felt both smart and proud that I then had some extra spending money to buy some of the latest sweaters and shirts, to go out on dates and to replace the gas I’d used driving my parents’ car around.
I must confess, looking for winners was my exclusive objective for many years. What I hadn’t done nor even gave much thought to was what most financial advisers recommend should be done first. I never consciously evaluated my tolerance for risk (truthfully, I was actually a stock market gambler) nor my objectives beyond winning in the stock market game.
I’ve had friends tell me
- they want to keep a year’s worth of their normal cash requirements on hand as insurance it might needed or
- they want their investments to generate a high dividend or interest yield because they need the income for living expenses without having to dip into principal or
- they pay 1-2% of capital to an investment advisor and wish they could manage their money themselves but just don’t have the time to do it or
- they have always invested exclusively in fixed income securities because they liked the security and steady income stream it provided but with rates being so low they have to now look at some stocks; what should they put their money into now that’s safe, they ask?
Wall Street has an answer to these questions and concerns. They can deal with investors who make the mistake of merely wanting to make money in stocks and they call it “portfolio management”.
SEI Investments Co. is a publicly-owned investment management firm who, according to their Yahoo Financial profile, provide wealth management and investment advisory services to corporations, financial institutions, financial advisors, high net worth families, banks and trust institutions, investment advisors, financial planners, not-for-profit organizations, and pension plans. Like other similar firms, their service offering is neatly package in what they call a “client-centric approach to wealth management“.
According to a brochure they provide to prospective clients and investment advisors [I’ve added the emphasis]:
“Goals-based investing offers a client-centric approach to wealth management, above and beyond investment management. It allows the advisor to combine the traditional methodologies of modern portfolio theory with the latest research on investor behavior.
The value of a goals-based investment strategy is that it goes beyond traditional yardsticks like relative performance against a benchmark. The focus is on goal achievement, which is what distinguishes SEI’s approach from others. Investment strategies are specifically designed around client goals, and performance is measured by the clients achieving their goals.
Goals-based investing involves creating a separate portfolio for each goal, as opposed to lumping all assets into a single portfolio. Whether the client is saving for retirement, funding a four-year education, or passing wealth to their heirs, there’s an investment strategy specifically tailored to meeting that goal.”
Other investment advisory firms offer similar approaches. For example, another describes their approach this way:
“Through personal discussions and/or use of a Risk Tolerance Questionnaire, goals and objectives based on a client’s particular circumstances are established. We then develop a client’s personal investment policy and create and manage a portfolio based on that policy. During our data-gathering process, we determine the client’s individual objectives, time horizons, risk tolerance, and liquidity needs. As appropriate, we also review and discuss a client’s prior investment history, as well as family composition and background.”
What these firms are really saying is that they will help you focus on your goals and then divvy up your assets into a number of different buckets, selecting mixes of investment offerings for each with different return, volatility and expiration. They give you a feeling that you actually are in control of your financial future and that, when you achieve the goals you have set for each bucket, you have performed well even if those results are significantly less than the most common benchmark, the S&P 500 Index, over the same period.
Obvious from the quotes above is the fact that most professional managers believe their chances of holding on to customers improve if they can encourage their clients to focus on the risks of losing principal rather than opportunities for portfolio growth. Individuals can anticipate how much and when they might need to withdraw sums of money in the future than it is for them to figure out how much profit a company will earn in future years, what the risk is that the company will miss those projections and whether domestic and international economics will put the projections in jeopardy.
Investors have seen and, perhaps, experienced the financial pain and wealth destruction that bear markets and crashes have caused and are afraid of becoming victims themselves. So “investment advisory” firms help them anticipate what amounts they’ll need for certain in 2, 5 or 10 years for such expenses as college tuition, wedding, house or retirement – expenses that may exceed income at the time and will need to be funded by savings. Advisors will then match those future financial demands with various funds they suggest which they believe will minimize the risk of not having the full amount when needed. The more chucks of “capital expenditures” you identify in your personal financial plan, the greater the number of segregated funds you’ll set aside today.
Your projecting your future financial needs, income and assets may be financial planning but is it “portfolio management”? Having someone tell you what asset classes and individual securities give the adequate returns with acceptable risk may satisfy your financial needs but does it provide the best management of your portfolio? Should we attempt to insulate our portfolios against risks determined from our projected expenditure needs or from economic, industry and company risks? Can individuals manage their portfolios in such a way that they contain portfolio risk yet still achieve better than adequate returns?
In the remaining articles in this series I’ll describe a portfolio management style that has worked for me and, perhaps, can work for you.