How to Build Your Financial “House”

What do a financial advisor and a building contractor have in common? On the surface, probably not all that much. Hopefully they can both help you to sleep well at night by providing you a solid foundation, sound advice and guidance, and cost-effective tips.

Think of your investment portfolio as a house. Each of the investments has a role. Bonds can be thought of as the foundation, providing income and long-term stability. Stocks can be the framing and roof, providing structure to your portfolio and positioning it for long-term growth.

If you are like most people, you need help building this “house.” You may ask around for referrals for a financial advisor, checking with friends or relatives to see whom they have used and if they have been happy. But often, it can be confusing to compare one type of advisor with another, as business models and investing styles differ so dramatically. This article discusses three of the most common types of investment advisors to help you understand which one may
be right for you.

Broker as Sub-Contractor

A sub-contractor is a specialist in one area. An electrician, for example, is a specialist who installs, operates, or repairs electrical equipment. The financial equivalent would be a broker, who typically has expertise in one focused area, such as large cap US stocks. The broker will buy and sell individual stocks based on his or her research and view of the markets. The broker can end up being less of an “advisor” and more of a stock picker.

When this makes sense: You want to be involved in the security selection or you have money that you want to allocate specifically to this asset class or firm. For example, you like your broker to call you with stock tips to discuss them before deciding whether to authorize him or her to go ahead with the purchases.

What to be aware of: A “sub-contractor” who claims to be a jack of all trades and all that you need. Just as you would not hire an electrician to do plumbing work or design your dream kitchen, a sub-contractor’s work should be limited to their area of expertise. In the same way that an electrician will likely not suggest you spend less on your high-end electrical work and more on your bathroom tile, your broker is not likely to tell you to allocate money elsewhere and lose potential commission dollars, even if it is in your best interest.

In addition, while this type of advisor may not charge a fee for their services, they are most often paid on commission. This means they get paid only when you buy or sell securities or certain investment products, which can create a conflict of interest. The concern you should have as a potential client is whether the investment recommended is truly the best one, or whether the advisor is recommending a certain investment because it enhances his/her bottom line.

Registered Investment Advisor as General Contractor

A general contractor (GC) is responsible for the overall coordination of a construction project. Similar to how you may hire a GC to manage a home construction project and oversee each sub-contractor’s work, you may choose to hire an independent financial advisor to manage your portfolio and oversee each of your investments.

When it comes to managing your money, the general contractor is typically a registered investment advisor (RIA), who is bound by a fiduciary standard and required to act in your best interest. This type of advisor is often at an independent firm (not a fund company or large bank) and uses third-party funds, meaning funds not affiliated with their firm. An RIA is generally fee-only, which means you pay an agreed upon fee which is usually based on a percentage of assets under management. The advisor earns no commission from the sale of financial products. Typically the management fee starts around 1.0%, and may decline considerably as the portfolio size increases. This form of compensation incentivizes the RIA to grow your assets. Check out our article on How to Choose a Financial Advisor.

Just like a general contractor’s role is to make sure that each sub-contractor building your home is doing their job– providing high quality work, on cost, and on schedule– this sort of financial advisor has a similar role. The advisor’s job is to understand each client’s long-term financial goals, risk tolerance, liquidity needs, and tax situation, and put together a plan that is best suited for that particular client. Once the overall asset allocation is determined– how much in stocks vs.
bonds, U.S. vs. international, etc. – the advisor will recommend the specific funds, implement
the plan, and review your portfolio on a regular basis to see if changes are needed.

When this makes sense: The “general contractor” is best for those who want an independent, unbiased approach to portfolio management. This advisory model provides diversification of the portfolio by strategy and fund. Whether you are building your portfolio (home) from scratch or rebalancing (renovating) your existing portfolio, it can be helpful to have a trusted advisor who understands your particular needs.

What to be aware of: People who claim to be general contractors but are not. Some advisors masquerade as GCs, say they are unbiased and conflict-free, and promise a balanced, diversified portfolio, but only use products managed internally or promoted by their firm that pay them high commissions.

Personality and overall fit are crucial. You are trusting this person to manage and grow your wealth, so it is important to have a good relationship and an understanding of the firm’s investment process. Every firm may be a little different with regards to how they allocate money between asset classes, the types of funds they use, and the performance reporting they provide, so it can be helpful to ask to see sample client materials.

Robo-Advisor as the Pre-Built Home

What if your goal is to buy a pre-built home in a planned community? This type of home has a standardized look and is often less expensive than building a custom home. The houses in the community will generally all have a similar style with only minor differences. The pre-built home does not require you to hire a contractor or sub-contractor. You would answer some questions on your ideal style of home, size, and budget, and then receive a recommendation.

The robo-advisor model to investing is not all that different. A robo-advisor is a type of financial advisor that provides portfolio management online with minimal human interaction. The investment advice is based on mathematical rules or algorithms.

There are many websites dedicated to this type of investing and they work in similar ways. First, the person is asked to answer a series of questions in order to assess factors such as age, investment goals, and risk tolerance. Then, the model uses low-cost, index funds to put together an allocation that is appropriate for the client. In most cases, the work is all done online with little to no human interaction. Some firms allow the client to have access to a representative for an additional cost. The management fee is generally on the lower end, in the range of 0.25% to 0.50% of assets under management.

When this makes sense: If you want a simple, low-cost and standardized approach to investing, a robo-advisor may make sense for you. The online nature often appeals to younger investors who may be more comfortable with a fully automated approach. While a pre-built home may not stand out from the pack and may not have all the touches you would choose if given the opportunity to build a custom home, it can be a comfortable place to live and the best solution for you.

What to be aware of: There is little to no human interaction, so this approach to investing may not be right for someone who wants a more personal relationship with an advisor and customized advice. A robo-advisor will not typically provide customized solutions and guidance for annual spending, saving for college, and retirement planning. Also, robo-advisors only use index funds, which track the area of the market they are investing in. While this eliminates the risk of a manager underperforming its benchmark, it does not provide an opportunity to beat the market, which is the goal of active management.

Ultimately, what type of “house” to buy or even whether to buy a house at all is a personal choice. What is right for your friend or relative may not be the right choice for you. So it is important to do research and ask questions as you would with any big decision. Happy “house hunting.”

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About the Author

Amy Brackett

Amy Brackett, CFA, is a Senior Vice President at The Solaris Group, and manages investments for individuals, families and non-profit institutions. Solaris is a specialized wealth management and investment consulting firm. The hallmark of the firm is to approach each client individually and with a deep understanding that the optimal portfolio is as much driven by the client’s circumstances as it is Solaris’ view of the markets.

Amy serves on the Finance Committees of Aghozo-Shalom Youth Village and The Bogliasco Foundation, and is on the Boards of Bowery Babes and Moms in Training, a program to benefit the Leukemia & Lymphoma Society. She lives in Manhattan with her husband and two children.

You can contact Amy at brackett@solarisgroupllc.com.

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