Let's Talk Asset Allocation Theory and AUM

[Justin Bilyj]

Interesting theory, but is this the only portfolio allocation theory out there? Recommend any others?
As far as portfolio selection, what kind of questionarre do you have and does it input into some software or do you use prefabricated funds based on time length?

Also, does anyone here double dip aum and commissions?
It seems kinda expensive to pay asset fees in addition to the asset fees of the funds themselves, thats 2.75%-3.5%!!!

I kinda want to get my cfp, but I am not excited about all the regulations and rules. Is it as constricting as I have heard? Can't scratch your ass without getting it approved!
Thanks for the feedback and advice guys.

 

[DHK]

You mean Modern Portfolio Theory? Modern portfolio theory - Wikipedia, the free encyclopedia


First, almost everyone who does NOT use MPT ideas, thinks that it's the goal of every investor to try to "beat the market". Since the great majority of mutual funds do NOT beat their market comparable benchmarks, you need to re-frame the discussion.


The art behind MPT is in taming the volatility of the portfolio without sacrificing returns. You want a low beta AND a high alpha compared to the appropriate portfolio benchmarks and risk profile.


If you like studying Standard Deviation, Alpha, Beta, Treynor, Sharpe, r2 and other statistical ratios, then maybe you can construct the investment portfolios on your own and matching various mutual funds together.


In my past investment career, I didn't use a questionnaire. I had a discussion. In essence, I draw a horizontal line and put numbers on it 1-6.
1 = CD at the bank (no risk)
5 = S&P 500 index
6+ = higher risk stuff, like penny stocks, etc.


'Where on this chart do you feel you would be most comfortable?' and let them choose.


Then I discuss how I make investment recommendations. "My goal is to help you lower your volatility and increase your returns... so you have the risk of a 3 or a 4, but get returns of a 5."


Then I discussed how we could work together: Mutual funds, mutual funds, or mutual funds.


The first group of mutual funds are standard mutual funds. They are the lowest cost, but no additional bells & whistles, or portfolio insurance. The cost is typically around 3% up front and 1% ongoing... "all in". (I was recommending a portfolio of American Funds or Franklin Templeton A-shares, and they are some of the least expensive funds available for registered reps.)


The second group of mutual funds was mutual funds with portfolio protection. This was a Variable Annuity. You insure your house, your car, and your life... why not your portfolio? Then I'd discuss how a particular living benefit would work, and the costs. The costs were about 3.5% per year - "all in" - living benefit rider, portfolio fees and the annuity costs. You may lose money in cash values over time, but the living benefit insures that you got all your money back over a period of time (or lifetime income).


The third group of mutual funds was "managed money". At the time, I was offering AssetMark wealth management (since bought by Genworth) and it had a multiple-money manager platform, with multiple strategists. I'd discuss the differences in asset management between strategic and tactical... and that it was all done to help reduce the volatility of the portfolio. If we didn't like the way a particular money manager was performing, we could 'fire' that one and pick another one within the same platform. The costs "all in" were around 2.75% per year (including the advisor fee and portfolio management costs.)


I never used any software for the recommendation, unless you're talking about an investment policy statement.


It's all conceptual. Sell the concept and let them think about how they want their money being managed.


In essence, if they like the way I choose investments, then let's work together. If the client wants to be a day-trader or dictate the relationship, then it won't be a good fit.


As far as 'double-dipping' commissions and fees... I wouldn't recommend doing both on the same asset/account. Doesn't seem right. However, if you're talking about insurance producers who earn commissions on insurance... and earn fees on AUM... it's done all the time.


If you're thinking that adding an advisory fee on top of the portfolio management fees is "double-dipping"... you're wrong. You're not 'double-dipping'. You are managing the relationship with the client, while the investment advisory group that is doing the active management/trading in the account is doing what they do. They are two different things. Now, if you'd feel better charging a consulting fee instead of fees for AUM, you can do that. But I think it's easier to get $10,000/year as 1% of $1 million... than to send a bill for it separately and ask the client to write a check.


As far as the CFP is concerned, the CFP BoS seems to think they can intrude into any area of your life when they receive a complaint. Take a look at this article here: Right To Use CFP Mark Revoked For Leader Of International Association Of Registered Financial Consultants, Edwin Morrow; CFB Board Acts On Complaint Against The Man Behind The RFC Designation-


I've also seen the 2" binder on Practice Standards that the CFP board puts out. They seem to want to micro-manage you and everything you do.


If you want a quality designation for investments & planning, I'd pick the ChFC and eventually move on to the CIMA or CFA.

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Something to keep in mind, if you want to enter the world of securities... is that clients have short memories.


No matter how clear you are, you need to document everything prior to the securities recommendation... because the REAL work comes after they're in the portfolio.


When the market tanks... and they're tracking their mutual fund... will they call you in a panic? Will you have to "talk them down off the ledge of wanting to sell out early"? That's a big problem of having mutual funds in the portfolio - it's easy to track their performance on a day-by-day, hour-by-hour basis.


The advantages of using RIA money management platforms is that you should be basing the relationship on the Investment Policy Statement. It will help bring clarity and logic to a panicked investor. Also, I *don't think* all their portfolios are available to monitor on a regular basis.


In addition, if someone wants out of the RIA investment program, you can just do it. If you were offering A-share mutual funds, compliance would wonder why the investor is liquidating their funds so quickly. Same thing with Variable Annuities - even with surrender charges being imposed. It would be your job to 'keep them invested'... just to keep your licenses and compliance record as clean as possible.




At least with Fixed Indexed Annuities and IUL... there are guarantees, and the potential of a decent return every year. No, it won't match the exact performance of the index - due to participation rates & caps... but it will certainly keep the panicked calls from coming in... because there is NO reason to panic - ever.

 

[Justin Bilyj]

That was a great post Dave, thanks for clarifying.
I meant double dipping as earning aum for their portfolio and earning commissions on their insurance.
Any chance you can clarify tactical?
Thanks,

 

[DHK]

To discuss tactical asset allocation, we have to also compare it with strategic asset allocation.


Strategic Asset Allocation Definition | Investopedia


I look it as being out in the middle of the ocean with a surfboard. The surfboard itself is the portfolio... riding the waves. The surfboard doesn't change much, particularly when it's out in the ocean. In order to change it, you can "go back to shore" and get a new surfboard and ride it for a while and see if you like it. You might also not go quite as far away from the shore to adjust for the risk tolerance. Waves won't go as high, but you won't get washed out either... at least that's the theory anyway.


Tactical Asset Allocation (TAA) Definition | Investopedia


Tactical asset allocation is minute, day-to-day, trading to take advantage of various changes in the economy as it happens. It's done on a risk-adverse way, so generally speaking, it preserves its capital far better than strategic asset allocation does.


Which one is better? yes. A good combination between the two is good to preserve assets and take greater advantages of market upswings.


Remember that just as mutual funds are not supposed to sway too far from the prospectus, the same with the style of investing according to an appropriate level of risk.


The only problem that I've seen with doing business this way, is that you get more calls when the market is up... and the account isn't up as far as the market is.

 

[Stephen]

I have 2 good buddies that are financial advisors. One of them uses DFA funds exclusively, and the other uses DFA as well as Vangaurd and several others that I can't remember.

Both of them charge a 1% fee, and use other outfits to pick the funds for another .5%, plus whatever DFA charges for the funds.

 

[Tahoe Ray]

That was a great post Dave, thanks for clarifying.
I meant double dipping as earning aum for their portfolio and earning commissions on their insurance.
Any chance you can clarify tactical?
Thanks,

There are plenty of those. They are normally classified as "fee based" advisors.

The majority of their income comes from the fees that they charge on AUM but also earn commissions on things like REITs, annuities, and life insurance.