Investment Management Isn’t Rocket Science
It’s remarkable to me how people are willing to open up about their personal finances when I tell them about my work. It seems that getting good help when it comes to investing and retirement planning can be difficult. I recently had a family friend tell me about her finances, and she said something that struck me. She said that her money was managed “by someone in California” because “Vermont didn’t have anyone sophisticated enough to do the job.”
I wondered whether she was facing a unique set of circumstances, but soon learned that didn’t seem to be the case. She was simply looking for the best asset manager she could find, and someone had convinced her that that level of sophistication didn’t exist in her backyard.
In my opinion, she was dealing with something that I hear about all the time from smart people. Financial professionals recognize that many smart people, even those with large sums of money, don’t have a deep understanding of investing. What they’ve found is that if they can make something seem extra difficult, they can convince you that they must be doing a good job. Most importantly, they can charge you more for what they do.
The truth is that asset allocation explains over 90 percent of investment performance. This means getting your balance of assets right does most of the job. Should you be holding more U.S. or emerging markets stocks? Should you be holding more Treasuries, gold, or real estate? Should you tilt your portfolio toward value or growth stocks? It depends on your risk tolerance, goals, and your time horizon. Stock selection and market timing account for less than 10 percent of performance (based on research of pension plans).
Getting your allocation right is difficult, and you may find that your money manager isn’t addressing your needs, but it’s not rocket science. Financial models are theoretical. The predominant underlying framework for many investment managers is called the efficient market hypothesis…I repeat, hypothesis. Many people have learned and mastered the principles of diversification and asset management.
So why does my friend’s investment professional choose to outsource the asset management to California? Probably because it sounds fancy, and perception is everything for salespeople. Low-cost asset management solutions are available through traditional investment managers and increasingly through automated “robo-advisors.” I never asked what she was paying, but I would bet a tidy sum that it was at least 1 percent annually. Unfortunately, paying more in fees is likely to lead to lower portfolio balances instead of higher ones. I encourage you to shop around to find an investment advisor that offers all-in costs, including the cost of the funds, around 1 percent or less per year.
The market isn’t rigged, as so many are led to believe, but not all the people that provide financial services are as forthcoming as we would hope. It’s in their interest to have you think that what they’re doing is extremely difficult, but remember that investment management isn’t rocket science. If your financial professional makes it seem like it is, they’re not doing a good job of describing what they do.