Diversification has long been an effective strategy for managing risk in an investment portfolio. Indeed, investing in assets that behave differently from one another dampens portfolio losses when certain markets are out of favor. However, there’s a common misconception that working with multiple financial advisors also diversifies portfolio risk. Unfortunately, in many cases this strategy has the opposite effect. In this article, we’re sharing why working with more than one advisor can introduce new risks to your investment strategy.
Risk #1: Lack of Coordination
Oftentimes, working with multiple financial advisors results in uncoordinated investment decisions. In other words, no one clearly assumes the role of quarterback for your overall investment strategy. As a result, you could be taking on too much—or too little—risk in your portfolio.
Even if you designate a primary advisor, problems can occur. One study conducted by State Street and Wharton found that 65 percent of investors who work with at least two advisors consider one advisor to be their primary advisor. However, more than half of these respondents say their primary advisor is not aware that other advisors are also managing their assets.
Risk #2: Unintended Tax Consequences
Except in certain types of accounts, paying taxes is the cost of a successful investment strategy. Any time your financial advisor places a trade on your behalf and realizes a capital gain, there’s an associated tax consequence. Similarly, distributions from your accounts are often considered taxable income. That said, one of the benefits of working with an advisor is that they can offset these gains to minimize your tax bill.
Unfortunately, working with multiple financial advisors makes it more difficult to take advantage of these opportunities. Indeed, each advisor may incorporate tax planning into their investment decisions. But if they’re not aware of what your other advisors are doing, their actions may result in you paying higher taxes than necessary. As an example, if one of the advisors does tax loss harvesting making sure that it does not run afoul of the IRS rules on wash sales, it could still run afoul of the rule across different accounts run by different advisors.
Risk #3: Excessively High Fees or Expenses
In general, financial advisors are compensated in client fees, sales commissions, or a combination of the two. That means as a client, you may be paying a combination of advisor fees and investment product expenses.
Many fee-based financial advisors and certain investments offer breakpoint discounts to attract more money. In other words, your overall fee decreases if your assets under management exceed certain thresholds. However, if you spread your money among multiple financial advisors, you may miss out on these breakpoints. Paying excessive fees can eat away at your investment results over time, diminishing your future nest egg.
Risk #4: Falling Short of Financial Goals
One of the most significant risks of working with multiple financial advisors is an unsuitable asset allocation. Your asset allocation is the mix of investments you own based on your financial goals, risk tolerance, and time horizon, among other factors. Some studies show that asset allocation accounts for as much as 90 percent of a portfolio’s performance. Meaning, the mix of investments you own is usually more important than which investments you own.
When two or more advisors are managing your wealth independently, there’s no guarantee your overall asset allocation will remain aligned with your goals. For example, your advisors may all share the same great idea that a certain asset class is going to perform well over the next few months. As a result, they may all increase your exposure to this asset class at the same time. This can create unintended concentration risk and lead to outsized losses if they’re wrong about their predictions.
Alternatively, your advisors may cancel each other out with their investment decisions. For instance, if one advisor adds an investment as another sells it, the net result on your portfolio is negligible. However, you may still pay two transaction fees. All of these uncoordinated decisions can have consequences that impede your progress towards your financial goals.
Bottom Line: Working with Multiple Financial Advisors Can Be Risky
When it comes to investing, we’re typically told not to put all of our eggs in one basket. So, it’s not surprising that this adage often extends to the financial advisor decision itself. Unfortunately, working with multiple financial advisors generally doesn’t have the same benefits as diversifying your investments.
The benefit of working with one financial advisor who you trust is that he or she can oversee your entire financial picture. That person can also coordinate with your other advisors—for example, your CPA or estate planning attorney—to make sure everyone is collectively working towards your goals. Having one, cohesive strategy can go a long way towards your future financial freedom.
If you’re looking for a trusted financial advisor to help you coordinate the various aspects of your financial life, please give us a call. We’d love to hear from you.