When high-net-worth investors consider using our firm, which manages wealth and offers a host of comprehensive portfolio management services, the documents they initially share with us often reveal the same set of mistakes. We find this is the case whether they’ve handled their own investing or have used a financial advisor through an investment bank or a robo advisor.
Here are the five most common mistakes wealthy investors should avoid.
1. Misunderstanding diversification
High-net-worth investors often think that being diversified means holding dozens of mutual funds or exchange traded funds — even if those funds are invested in similar assets, thereby duplicating exposures and, in many cases, increasing overall risk.
It makes no sense to be in multiple investment vehicles that do the same thing. A truly diverse portfolio holds a variety of assets distinguished by stocks and bonds: U.S. and international; large, medium and small cap; growth and value; industry sector; and geography. In addition, a portfolio can benefit from a mix of passive and active strategies, which should serve to lower the overall volatility so it does not live and die by the swings of the market, leading to better long-term returns.
A related problem is that our new clients tend to be in so many investments that none of their holdings are actually making a significant impact on the portfolio, even if they are a good investment. With so many positions, they’ve simply created a lot of noise instead of a well-orchestrated symphony.
2. Uncoordinated management
This typically occurs because a high-net-worth investor has selected multiple firms or advisors instead of working with a quarterback to select the players, call the plays and see the whole field. Since this is a service our firm offers, we naturally feel strongly about this particular error. We believe it leads to a complete lack of coordination across the portfolio due to advisors who are unaware of each other’s existence. Even if each portfolio or individual investment makes sense on its own, together they may be fighting against one another.
Investors also need an advisor who can coordinate rebalancing across a portfolio to maximize after-tax returns and prevent unnecessary gains and wash sales. For example, last year when the pandemic started there was a significant pullback in the market. We used this opportunity to do strategic tax-loss harvesting where clients booked large unrealized losses to offset against future gains. If you’re not watching the market and you’re off by a couple of days (something that happens often if you’re using multiple firms that aren’t coordinated with each other), you could lose out.
3. Unpersonalized portfolios
The allocation mistakes above can happen because the investor is using a robo advisor. Despite the allure of an “easy button,” automated investing is not always wise — especially at the portfolio creation stage. The amount of information robo advisors collect about clients is very limited: income, age, savings. But an investor needs to dig deeper than that. For example, what life events are impending that will require you to have funds to spend — events such as buying a house, having a baby or retiring?
An intake form isn’t enough. Advisors can’t capture everything they need to know until they sit down with people and learn who they are. A portfolio that isn’t tailored to the individual can lead to bad behaviors like panicking and selling when the market bottoms because not enough cash was set aside for liquidity needs. It’s also not a one-time conversation but an ongoing process, as clients hit different life stages and events.
And then of course there is the issue of what a human being can do that a computer can’t — the ability to actually interact with another person. We had a new client who was using a robo advisor and he couldn’t even reach an actual human on the phone to transfer the funds. Like Hotel California, you can check in, but you can’t check out. A good wealth management firm should be available when you need them.
Having actual people look at financial documents can reveal other obscure, but important, details. We once discovered that a wealthy client who had been a self-directed passive investor had unknowingly listed his administrative assistant as his beneficiary on his IRA. When investing, details are important, and be assured a robo advisor will avoid getting in the weeds.
Be who you are online, but not too much, experts say.
4. No accounting for behavior
In addition to financial planning and allocation, we consider investor behavior, including risk tolerance. For example, with the decline in the market in the early days of the pandemic, we needed to know: could a client withstand a 40% drop in the market? Generally, do they have patience? A good advisor will get to know an investor’s behavior and lifestyle in order to build a personalized portfolio that suits their economic and emotional tolerances.
Investors’ internal biases are also a problem. Like avoiding real estate as an investment because you already have such an asset — your house. A house isn’t really an investment; it’s a home. Unless you’re flipping houses, you typically don’t own one to sell or trade it. You own it to live there — even if you sell, you’ll need to buy another home or pay rent. Many times, investors are missing a crucial piece of the pie, simply due to incorrect beliefs.
5. FOMO-mania
Investors, especially young ones, tend to want to chase the hot stock of the day. We have to point out that many such equities are overvalued and buying and selling them is based on rumor and speculation rather than research and true economic valuation.
Young investors are also drawn to trendy trading platforms like Robinhood, enticed by the commission-free trading but not realizing that nothing is free. Such platforms don’t provide transparency concerning bid/ask prices and so investors don’t know if they’re paying a reasonable price for the product, and often become the product themselves.
