Last week I received an e mail from someone who wanted to discuss a possible career in the investment advisory arena. He’d had a successful career in some other industry, and, because he enjoyed the process of managing his own portfolio (and apparently was successful at it), felt a “calling” to help other people reach their financial goals as well.
In the ensuing phone conversation, I could tell within two minutes that his approach to investing was far different than the “Coffeehouse” approach to wealth management. He explained to me that he had done significant research on one sector of global investing, and felt he had a special knack for picking the top-performing stocks and industries within this sector, and wanted others to be able to benefit from his wisdom.
After pressing him a little, specifically asking him what his clients should do in the event he happened to be wrong with his future predictions, he admitted that he embraces the “Coffeehouse” philosophy of broad based index funds, but felt that part of a client’s portfolio warranted his insights.
His approach toward providing financial advice comes as no surprise to me. In the world of stockbrokers and financial advisors, this is more commonly referred to as “core and explore.” The sales pitch goes something like this: “We are going to invest three quarters of your common stock investments in low-cost index funds, and try to beat the market with one-quarter of your holdings.”
Although advisors in the financial industry talk a good line – about diversification, about market efficiencies, and the need for financial planning, most of them still spend the vast majority of their time analyzing and trying to beat the market, even if it is with only a portion of your portfolio.
The downside to a core and explore approach is two-fold. First, any attempt to “beat” the market, even with a small portion of your portfolio, is likely to have a disastrous impact on the long term performance of your holdings. Don’t believe me? Check out your returns over the past ten years compared to the Coffeehouse portfolio, and that is proof enough.
Second, and more important, when your stockbroker turns his attention to beating the market, either through individual stocks, actively managed funds, or exchange-traded sector index funds, there is a natural tendency for you to shirk responsibility for your own financial well-being, because you are now relying on someone to predict the future.
To put it bluntly, if reaching your financial goals is dependant on someone’s ability to predict the future with the “explore” part of your portfolio, you are in big trouble.
Most of the stockbrokers and financial advisors just don’t get it. The reality is that the vast majority of investors couldn’t care less about beating the market, even with a fraction of their portfolios. The only reason they might think it is important is because some salesman has convinced them that it is important.
What investors do care about is whether or not they are on track to reach their financial goals, what they need to do to reach their goals, and whether they have a portfolio that broadly reflects where they are at in life in relation to their goals.
The next time a stockbroker or financial advisor starts talking about his favorite “core and explore” portfolio, run the other way. He is looking out for his own interests a lot more than he is looking out for yours.