What you should expect from your investment manager
Financial advising is a broad term used by professionals who cover a wide range of responsibilities and expertise. In this week’s blog, we want to focus on one of the key roles that a financial advisor can serve as: investment manager. Investment management is one of the most integral components of planning and success as a client. While most financial advisors will simply ask you about your goals, ask for your risk tolerance, and invest your assets, here at Mana, we believe that investment management should go much further. Going beyond this basic evaluation and implementation helps us align with our clients and ensure that they continually move towards their goals and dreams.
What we’ve learned in serving over 100 families is…
Goal work takes time: Sometimes you know your goals, but don’t know how to prioritize them. Sometimes you haven’t stated a goal because you haven’t felt like it could be possible. Sometimes you don’t even know where to begin with setting a goal.
Risk tolerance can’t be fully captured in a single, blanket value, and it isn’t the whole story: Family history, your relationship with money, and your goals around money will impact your risk tolerance. Risk tolerance can’t be stated as a summary point. Sometimes you’re willing to take different levels of risk for different buckets of assets. The amount of risk you’re objectively able to take (risk capacity) also matters.
Investment management shouldn’t be executed as a one-time event: Life doesn’t stand still, and neither should your investment strategy. As your circumstances shift—whether through career changes, family growth, or new financial aspirations—your portfolio needs to evolve in tandem. What we’ve learned is that the real value of investment management lies in the ongoing process of fine-tuning your strategy to reflect where you are today and where you want to be tomorrow. The initial plan sets the stage, but it's the continuous oversight and adjustments that ensure your investments stay in sync with your life’s journey.
To effectively invest for a family, we believe it’s an investment manager’s responsibility to go deeper. Today, we’ll share our insights on how to approach investment management.
Goal work: beyond the basics
Goals are the foundation of any investment strategy, but they’re not always clear-cut. Effective goal setting goes beyond merely identifying financial objectives. It requires a deep understanding of the motivations and values behind these goals. For instance, retirement planning isn't just about accumulating a certain amount of money; it's about envisioning the life you want to lead in retirement and the legacy you wish to leave behind. Understanding these motivations helps in tailoring a financial strategy that truly aligns with personal values.
Effective goal setting involves prioritizing multiple goals and conducting a feasibility analysis. Many investors struggle with prioritizing their financial goals, leading to ineffective planning. By carefully assessing which goals are most urgent and realistic given current resources and future earnings, an investment manager can create a roadmap that balances immediate needs with long-term aspirations. This approach not only helps in achieving financial security but also ensures that the plan remains adaptable to changes in life circumstances.
Goal setting must consider both behavioral insights and the need for adaptability. Behavioral biases, such as present bias or emotional decision-making, can derail financial planning. Investment education can help to support individuals who have these biases, ensuring that clients stay on track toward their long-term goals. Additionally, goals should be revisited and adjusted as life events and economic conditions change, allowing for a financial plan that remains relevant and effective over time. By incorporating these elements into the goal-setting process, you can achieve a financial future that is not only secure but also deeply aligned with their personal values and life aspirations.
Risk Tolerance: Not just a simple survey
The concepts of risk tolerance and capacity involve understanding that these factors are not merely about one's comfort with market fluctuations. Risk tolerance is deeply influenced by an individual’s personal history, relationship with money, and specific financial goals. For example, someone who grew up in a financially unstable environment may have a lower risk tolerance, even if their current financial situation allows for greater risk-taking. This psychological and emotional context plays a crucial role in how investment decisions are made, and it's something that a knowledgeable investment manager will consider carefully when developing a strategy.
Moreover, risk tolerance should not be viewed in isolation from risk capacity—the actual financial ability to withstand losses. An individual may feel comfortable taking on high-risk investments, but if their financial situation doesn’t support such a level of risk, it can lead to disastrous outcomes. Research indicates that personalized advice is becoming increasingly sought after, with the "advised" investor segment growing from 35% in 2009 to 47% in 2023 (ThinkAdvisor). This trend underscores the importance of considering both risk tolerance and capacity in a holistic manner, ensuring that investment strategies are tailored to an individual's unique financial and emotional landscape.
Another critical aspect of risk assessment is recognizing that risk tolerance can vary across different asset classes or financial goals. For example, an individual might be willing to take on higher risk for their retirement portfolio, which has a long time horizon, but prefer lower-risk investments for funds needed in the short term, such as a down payment on a home. This nuanced understanding of risk requires a more sophisticated approach, where it is the role of an advisor to assess risk on a granular level, taking into account the specific purpose of each investment bucket.
Finally, it’s important to remember that risk tolerance and capacity are not static; they evolve over time. Life events such as marriage, the birth of a child, or a change in employment can significantly alter both an individual’s risk tolerance and capacity. Economic shifts, too, play a role. As these changes occur, it is the job of an investment manager to be adaptable, continuously reassessing and adjusting the investment strategy to ensure it remains aligned with a client’s current situation and future goals. By understanding and integrating these aspects, a well-rounded approach to risk management can be achieved, leading to more resilient and personalized investment strategies.
Building a portfolio: beware of advisors who advertise their superiority
Building portfolios for clients is a very important responsibility of a financial advisor, but beware of financial advisors who advertise their superiority in investment management. The SPIVA U.S. Year-End 2023 report, published by S&P Dow Jones Indices, provides detailed insights into the performance of actively managed funds compared to their respective benchmarks. The key takeaway is that a significant majority of active managers continue to underperform their benchmarks over various time horizons. For example, over a 20-year period, 94% of domestic equity funds underperformed the S&P Composite 1500 Index. Large-cap funds, in particular, struggled, with 93% failing to beat the S&P 500 over the same period. The report also highlights that even over shorter time frames, such as one, three, and five years, the majority of active funds in categories like large-cap, mid-cap, and small-cap also failed to outperform their benchmarks. These findings underscore the difficulty of active management, especially when considering the higher fees and expenses associated with these funds. As a result, many investors may find that passive investment strategies, like index funds and ETFs, offer better long-term performance and value (etf.com).
Investment managers should focus attention on understanding the client’s unique financial goals and risk profile, and determining an asset allocation that aligns with the investor’s goals. Asset allocation is critical because it defines how investments are distributed across various asset classes, such as stocks, bonds, and alternative investments. Research from Vanguard has consistently shown that asset allocation is a critical driver of long-term investment returns, with studies indicating that around 88% of the variability in a portfolio's returns over time can be attributed to its asset allocation, rather than to individual stock picking or market timing efforts.
Approaches to portfolio construction can vary, and while there’s no ‘right’ way to do it, understanding how an advisor considers fees, liquidity, risk management, and tax management are all important.
Accountability and Investment Oversight
Effective investment management is not just about making the right initial decisions; it’s about consistently monitoring and adjusting your portfolio to ensure it stays aligned with your financial goals. This process involves a balance between automation and regular check-ins. Automating parts of your financial plan, like contributions to retirement accounts, can simplify your financial life, but it’s crucial that your advisor also conducts regular reviews to avoid potential pitfalls, such as cash drag.
Cash drag refers to the negative impact on portfolio performance when a portion of the portfolio remains in cash rather than being invested in assets that generate returns. The issue is particularly pronounced during periods of low interest rates when the returns on cash are minimal or even negative after accounting for inflation. Studies have shown that holding too much cash can significantly reduce long-term returns. For example, according to a Morningstar study, over a 30-year period, cash drag can reduce an investor’s portfolio growth by as much as 1% per year. While 1% might seem small, compounded over decades, this can lead to a substantial reduction in overall wealth.
Moreover, research from Vanguard indicates that missing out on just a few of the best days in the market can drastically lower overall returns. For instance, an investor who missed the 10 best days in the market over a 20-year period could see their returns cut in half. Holding excess cash increases the risk of missing these critical market days, further emphasizing the importance of minimizing cash drag in a portfolio.
To mitigate the effects of cash drag, investment managers should perform regular portfolio reviews. These reviews ensure that cash balances are kept at optimal levels, invested appropriately based on market conditions, and that the portfolio remains in line with the investor's risk tolerance and financial goals. This approach allows investors to take full advantage of market opportunities, reduce opportunity costs, and maintain the growth potential of their investments.
Taxes matter!
Effective investment management isn’t just about selecting the right assets; it’s also about ensuring that your portfolio is tax-efficient. Taxes in the portfolio can significantly impact your net returns, making tax strategies a critical component of financial planning. One such strategy is tax loss harvesting, which involves selling securities at a loss to offset capital gains in other parts of the portfolio. This tactic not only reduces your current tax liability but also allows you to maintain your portfolio's overall risk profile by reinvesting the proceeds into similar assets. Research suggests that tax loss harvesting can boost after-tax returns by approximately 1% annually, a difference that can compound significantly over time.
Beyond the immediate benefits of tax loss harvesting, a forward-looking approach to tax planning is essential for long-term financial health. This involves strategies such as opportunistic income escalation, where income is recognized in lower tax years, Roth conversions to take advantage of lower tax rates, and maximizing retirement contributions to reduce taxable income. These techniques are not just about minimizing taxes in the current year but also about strategically planning for the future to enhance overall financial well-being. By reducing your tax burden over time, these strategies can significantly improve your portfolio's long-term performance and help you achieve your financial goals more efficiently.
Your advisor’s strategy should adapt with you
The financial markets and personal circumstances are in constant flux, making adaptability a vital trait for any effective investment manager. The ability to pivot and reassess your investment strategy as conditions change is key to maintaining alignment with your goals. This means that your advisor should not only respond to market movements but also proactively adjust your portfolio in anticipation of changes in the economic environment or your life circumstances.
As you progress through different life stages—such as transitioning from wealth accumulation to retirement income distribution—your investment strategy must evolve to reflect your changing needs and goals. This might involve shifting from a growth-oriented portfolio to one that emphasizes income and capital preservation, or it could mean adjusting asset allocations to better manage risk as your time horizon shortens.
Being adaptable also means staying informed about new financial products, regulations, and strategies that could benefit your portfolio. An advisor who is adaptable will continuously seek out opportunities to improve your portfolio's performance, whether through tax-efficient strategies, optimizing asset allocation, or incorporating new investment vehicles that align with your objectives. In a dynamic financial landscape, adaptability ensures that your investment strategy remains relevant, effective, and aligned with your long-term goals.
Finding a fiduciary
Financial advice should empower and protect your hard-earned wealth. But in an industry filled with varied titles and qualifications, how do you ensure you're working with someone who has your best interests at heart? The answer lies in choosing a fiduciary.
A fiduciary is legally obligated to act in your best interests, a commitment that aligns with our fee-only, client-centered approach. Unlike brokers or advisors tied to commission-based structures, fiduciaries provide unbiased advice tailored to your unique financial landscape. Fiduciaries prioritize your goals, ensuring that every recommendation is made with your success in mind. True financial well-being is about more than just numbers—it's about empowering you to live the life you envision, with confidence and clarity.
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Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.