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Use of Professional Financial Advisors is Changing
What You Can Learn from Wealthy Investors

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
May 17, 2011

IN THIS ISSUE:

1.  More Wealthy Households Have Multiple Advisors

2.  44% Fired Their Primary Financial Advisor

3.  Top Reasons Wealthy Clients Use Professional Advisors

4.  Why Multiple Advisors?

5.  Multiple Advisors Not Just for the Rich

6.  Managing Downside Risks

Introduction

Over the years, it’s been no secret that I recommend the use of professional Investment Advisors (“Advisors”) for your money management needs.  The reasons for this are many as I will discuss later on, but first I want to highlight some recent changes that investors are making in their advisory relationships.

Many investors make the mistake of thinking that the use of professional Advisors is only for the wealthy.  After all, it makes sense that wealthy households probably use Advisors more than other investors, given that they typically have a lot more money to invest.  Plus, wealthy households usually have the need for estate planning, business succession planning, help with charitable contributions, etc. 

However, the use of professional Advisors should not be limited to only the wealthy.  I have long recognized that many individual investors have family and investment situations that are similar to those experienced by the wealthy.  The only problem is that regular investors don’t have an army of financial advisors chasing them, trying to get their business.

It has long been one of my business goals to expand the specialized services once reserved only for the wealthy and make them available to virtually any serious investor.  Thus, when I read anything about what the wealthy are doing in regard to their investments, I naturally think of how their experience can be beneficial to the readers of this E-Letter.

A recent study released by Cerulli Associates, Inc., a market research firm, found that wealthy households have, indeed, changed the way in which they approach the use of professional Advisors in recent years.  Cerulli’s research involved households with at least $10 million in investable assets.  In this week’s E-Letter, I’m going to discuss the Cerulli study in detail, as well as tell you how you can benefit from its findings.

More Wealthy Households Have Multiple Advisors

With two major bear markets in less than a decade, most investors of all sizes have seen their portfolios and their retirement funds decimated.  This, in turn, led to one of two actions by many of these investors.  Studies have shown that many investors who had used professional money managers fired them during or after the worst of the bear markets.  The obvious reason is that they performed no better than the market, so some individuals decided to take the reins of their own portfolios and become do-it-yourself (DIY) investors.

Ironically, many who were already investing on their own found that their portfolios were also hit hard by the bear market, so they actually sought out professional money managers.  The 2008 bear market and financial crisis showed them that they either weren’t qualified or just didn’t want to to manage their own investments going forward. 

All told, we have seen a significant rise in the number of investors who have turned to professional Advisors.  In fact, among wealthy investors, most use multiple professional Advisors.  In a study released in late March, Cerulli Associates found that 57% of wealthy households are working with five or more professional Advisors.  Almost 64% are working with at least four Advisors.

That is a huge jump!  In 2008, barely 16% of wealthy households had four or more Advisors, according to Cerulli.  As an indication of how much has changed, just 19% of such households now work with just one advisor.   Robert Testa, a Cerulli senior analyst, noted:

“During the financial crisis, we found that high-net-worth investors started to increase the number of financial advisers they were working with, even though there will often be one alpha [primary] adviser among the relationships.”

In the Cerulli study, “financial advisors” included private banks, brokerage wirehouses, private client services and Registered Investment Advisors (RIAs) with the Securities and Exchange Commission.  My company, Halbert Wealth Management, Inc. is one such RIA out of some 20,000 or so around the country.  Obviously, with such a large number of RIAs out there, the number and types of services vary greatly from RIA to RIA.  Some offer detailed financial, tax and estate planning while others, like my firm, concentrate on investment management.

Cerulli senior analyst Katharine Wolf believes that one reason wealthy households are increasing the number of Advisors they use is to diversify the solvency risk.  To that I say, why have any Advisor solvency risk at all?  There are plenty of professional Advisors that do not require custody of your money, leaving that duty to an independent third-party firm.

For example, my firm uses the services of Fidelity, TD Ameritrade and other well-known independent custodians to hold client money and execute trades.  This way, no matter what happens to me or my firm, our clients’ money is safely held in an account in their names and under their control.

44% Fired Their Primary Financial Advisor

Not surprisingly, the Cerulli survey of wealthy households confirmed that many investors had fired their previous Advisors.  In fact, 44% of wealthy individuals fired their primary Advisor in the last year or so.  Frankly, I would bet that number is on the low side since some wealthy investors don’t want to admit that they had to fire their lead Advisor.

This brings up a key point when deciding on whether to use professional Advisors to manage your money.  Just because a firm is an RIA or other financial professional does NOT mean that they are successful.  Many (if not most) Advisors still use “buy-and-hold” strategies that are highly correlated to the overall stock market.  Thus, they tend to only make money when the markets go up and they lose money when the markets go down.

Take a look at the S&P 500 Index chart below.  When the “dot.com” bubble burst in 2000, the S&P 500 plungedalmost 45% by late 2002.  It took five years for the market to fully recover.  Unfortunately, millions of investors bailed out during the bear market and missed the recovery.

S&P 500 Index Nearest Futures

When the credit crisis erupted in late 2007 and 2008, the S&P 500 plunged over 50% and, again, millions of investors bailed out, many near the lows.  Now, some three years later, the market has still not recovered to the pre-crisis highs.

Advisors can be a pretty creative group when it comes to marketing their services.  They come up with lots of fancy names for their strategies.  But whatever they may call them, if buy-and-hold is at the core of their strategy, you’re likely going to be on a violent roller-coaster ride.

This is why I believe the Cerulli Associates number – that 44% of wealthy households fired their lead Advisor – is on the low side.  Obviously, most fired their lead Advisor because they wanted off the roller-coaster!  The point is, when considering hiring an Advisor, you definitely want to see their performance during the 2000-2002 bear market and again in 2008.

Top Reasons Wealthy Clients Use Professional Advisors

The Cerulli survey asked wealthy households why they use professional Advisors.  I’ll list the responses below.  But before hiring an Advisor, an investor has to reach a personal decision to turn all or part of his/her portfolio over to a professional.  For some investors, it’s a no-brainer, especially if they are looking at a real performance record that is better than their own results.

For others, however, it’s a gut-wrenching experience.  Turning the reins over to a professional is sometimes seen as an admission of failure.  Rather, I see it as an admission that you’re just not emotionally suited for buy-and-hold and the roller-coaster experience.

Most people who have a sizable nest egg made their money in their primary business where they were very successful – and not because they made a killing in the markets.  Many decide to hire Advisors because they simply do not have the time to devote to investing.  And if you neglect your investments, the results can be disastrous.

Perhaps one of the best reasons for having multiple Advisors is the wide array of financial goals shared by the wealthy.  Part of Cerulli’s nationwide survey included a question about each high-net-worth household’s most important financial goal.  The results and percentage of households that listed each as the most important goal are as follows:

1. Maintain Lifestyle in Retirement: 31.7%
2. College Education Funding: 19.6%
3. Protect Current Wealth: 14.6%
4. Aggressively Grow Wealth: 14.0%
5. Leave Estate for Heirs: 9.8%
6. Charitable Giving: 4.2%
7. Minimize Income & Cap Gains Taxes: 2.4%
8. Improve Household Cash Flow: 1.9%
9. Manage Market Risks: 1.8%

Given the wide variety of goals, it makes sense that wealthy families would seek out multiple Advisors to make sure they are getting “specialists” in each area of expertise. 

Why Use Multiple Advisors?

So we can probably agree that it is a good idea to use professional Advisors to help take the emotion out of investing.  However, can’t this be done with just a single money manager?  Why do these wealthy households feel the need to have multiple Advisors?  The answer is one of the most basic of investment management – diversification

Why did 44% of wealthy individuals fire their primary Advisor?  Likely because they added no value when the bear market hit.  If you’re going to be stuck in a buy-and-hold asset allocation strategy and suffer drawdowns similar to those of unmanaged index mutual funds, why pay a fee for the privilege?  These investors thought they were getting diversification, but they ended up with portfolios that were highly correlated to the markets.  Without an escape hatch to move to cash or hedge their positions, these strategies bombed right along with the markets.

Those wealthy investors who have now rehired Advisors or former do-it-yourself investors who are hiring Advisors for the first time are approaching the process much like a money manager would when building a portfolio.  Investors are now looking for strategies that offer real diversification and are not highly correlated to each other, meaning that they don’t tend to go up and down at the same time.

Today, many wealthy investors are seeking out active management strategies that have the flexibility to move to cash or hedge to avoid losses during bear markets.  These investors are also seeking out “alternative-type” investments, which typically involve commodities and managed futures, as well as strategies that employ long/short trading and the use of leverage. 

Wealthy investors are also interested in diversification because of the many Ponzi schemes that the recent bear market exposed.  While some people see a bit of poetic justice in the rich being scammed by Bernie Madoff or one of the other bogus financial advisors now headed for prison, the truth is that we can all learn a lesson from their loss.

No Investment Advisor should be treated like a rock star and considered to be above the due diligence process.  At my firm, we have an extensive due diligence process that seeks to weed out the good Advisors from the bad, and no one escapes our scrutiny.  In fact, we consider it to be a major red flag if an Advisor acts as if it is beneath him or her to answer detailed questions about the firm’s background, strategies or administrative processing.

Multiple Advisors Not Just for the Rich

I view the move to multiple financial advisors as a major plus for investors, and it’s not just limited to those with $10 million or more of investments.  As I noted earlier, it has always been my desire to offer specialized strategies and techniques once reserved for the rich to regular investors.  I think there is a very valuable lesson to be learned from the Cerulli study for all investors, no matter what their net worth.

Looking at the list of most important goals above, I don’t see any that would not also be important to the average US household.  Even those like #3 about protecting current wealth and #5 about leaving an estate for heirs can apply to just about any serious investor.  While wealthy investors may have more to protect or leave to heirs, their needs are no more important than those with more modest nest eggs.

The wealthy are also not alone in needing estate and other life planning.  For example, if you have a blended family situation, it’s likely that you need to have an Advisor that specializes in estate planning.  The same goes for anyone who has elderly parents under their care, a child with lifelong special needs or children who will need a college education.

Unfortunately, many investors, including some of the wealthy, limit their investment advice to a single financial planner or broker, which often limits access to different strategies.  It’s unrealistic to think that a single Advisor can be an expert in all types of strategies, so limiting yourself to one broker or financial planner will usually mean limiting your access to strategies that could offer true diversification.

The lesson to be learned from the Cerruli study is that the use of a professional Advisor can be very beneficial, even if you’re not “rich.”  Even though investors may have less than $10 million to invest, many are still interested in alternative and actively managed strategies like those discussed above.  Fortunately, such strategies exist and are available at minimums far less than those required by so-called “hedge funds.”

The Cerruli study shows that having multiple Advisors can be very beneficial, depending upon the strategies used.  But you also must be very careful in your selection process.  If you have five different money managers but all recommend a buy-and-hold asset allocation strategy, then you really don’t have any real diversification.

Managing Downside Risks in the Markets

I found it interesting in the above list of most important goals that the desire to protect wealth and to manage market risks were listed separately.  Aside from insurance protection, the goal of managing market risks is an integral part of protecting wealth.  One of the most common things we hear from clients who have just retired or sold a business is that they want strategies that will help to maintain their wealth, whatever it may be.

As I noted above, buy-and-hold strategies do NOTHING to manage downside risks.  You’re asked to ride-out bear markets and significant downward “corrections.”  There are only two ways to manage downside risk in the market: 1) Exit long positions and move to the safety of a money market fund; or 2) “Hedge” long positions with options or “inverse” funds.  Inverse funds are designed to go up when the market goes down.

Obviously, most investors are not good at this.  Frankly most Advisors aren’t either.  Wall Street has preached for years that “timing the market” is impossible, when they know full-well better.  While most Advisors are not successful at timing the market, there are some that have been doing it successfully for years.

At Halbert Wealth Management, our job is to find those Advisors with winning systems and strategies and attractive actual performance records based on trading real money.  Each of the Advisors we recommend has a time-tested system for spotting trends in the markets.  If the system signals that the major trend is turning down, some can move out of the investments they own and into the safety of a money market fund until the trend turns up again.  Increasingly, some also use specialized “inverse” funds to hedge their long positions (so they don’t have to sell them).

Either way, the goal is to limit losses during downturns, while being invested during most of the uptrends in the market.  Some of our recommended Advisors specialize in stock mutual funds, while others invest exclusively in bond funds.  We even have one very successful Advisor that invests only in convertible bonds, which I wrote about in my  October 12 E-Letter on retirement income.  We also have a manager that invests exclusively in Exchange Traded Funds (ETFs).

Conclusions

Long-time clients and readers know that I started my investment career in the commodities futures markets in the mid-1970s.  My original company, ProFutures, Inc., organized several professionally managed futures funds.  Unlike most managed futures funds today, I sponsored publicly offered funds that were available to virtually any suitable investor. 

In this way, I was able to bring the advantages of an alternative investment class to a wide array of investors who wanted this additional diversification.  In addition, these funds invested with multiple third-party Advisors that made the day-to-day investment decisions.  So, you might say that I recognized the importance of multiple Advisors almost 25 years ago.

The point is that I decided decades ago that there were professionals out there who are better than me when it comes to managing my clients’ assets.  That’s why I’ve made a career out of searching for, and finding, truly successful third-party Advisors and making them available to my clients.

In almost all of our client relationships, we are one of several Advisors or brokers employed by the investor.  Some of our best relationships are with clients who have a lead Advisor (sometimes it’s us, sometimes it’s not) who understands the need to diversify among investment strategies and help the client arrive at an effective allocation.

While I am pleased that many of my readers understand the importance of diversification among investment professionals, we know that there are still others out there who feel that it would be disloyal to bring another Advisor into the mix.  To that I would say that it’s more important to be loyal to your financial goals and diversification of your portfolio.  After all, that’s how some of the wealthy investors polled in the Cerulli study got that way.

If you have any questions about diversifying your portfolio or the types of actively managed strategies my firm offers, please feel free to call one of our Investment Consultants at 800-348-3601 or send an e-mail to info@halbertwealth.com.  The consultation is free and there’s never any obligation or pressure to invest.  We have professionally managed investments with minimums as low as $25,000 to accommodate almost any serious investor.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES:

Active Management the New Buy & Hold? (Requires registration)
http://www.investmentnews.com/article/20110508/REG/305089965

More Bad Signs for the U S Economy
http://www.cnbc.com/id/43062381

 


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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