Model Portfolios

There is a common criticism in the investment world that financial advisors who use model portfolios aren't really managing their clients' money.

I think that criticism misunderstands what good investment management should accomplish.

A financial advisor doesn't necessarily add more value by personally selecting every mutual fund or stock in a client's account. In many cases, using a professionally managed model portfolio can give clients access to greater investment resources, broad diversification, disciplined portfolio management, and lower-cost investment options.

What Is a Model Portfolio?

A model portfolio is a professionally constructed investment allocation designed around a particular objective or level of risk.

Rather than relying solely on an individual advisor to research and select every investment, a model may be constructed and monitored by a dedicated investment team. These teams often include CFA® charterholders and other investment professionals whose primary responsibility is researching markets, selecting investments, and managing portfolios.

For an investor, that can mean having an additional layer of professional expertise working on the portfolio.

Professional Management Can Be a Strength

Financial advisors wear a lot of hats.

On any given day, we may be helping clients with retirement income, Social Security, tax planning, Roth conversions, insurance, estate planning, cash flow, or investment decisions.

Investment management firms, on the other hand, can have entire teams dedicated specifically to portfolio construction and investment research.

Using those resources isn't outsourcing responsibility. The advisor still has the responsibility of determining whether the portfolio is appropriate for the client.

The investment team can focus on how the portfolio is managed, while the financial advisor focuses on how that portfolio fits into the client's overall financial plan.

Diversification

One of the biggest advantages of a well-designed model portfolio is diversification.

A portfolio can provide exposure across different areas of the market, including U.S. large-, mid-, and small-cap companies, international and emerging markets, and multiple areas of the bond market.

Diversification doesn't eliminate investment risk, but it helps avoid making a client's financial future overly dependent on a particular company, sector, investment style, or part of the market.

A professionally constructed model provides a repeatable process for maintaining that diversification over time.

Cost Matters

Investment expenses matter because every dollar paid in investment costs is a dollar that isn't available to compound for the investor.

Many model portfolios today utilize relatively low-cost ETFs and other investment vehicles.

That can compare favorably with traditional commission-based mutual fund arrangements, particularly older A-share mutual funds that may carry higher underlying expenses and, when originally purchased, may have included an upfront sales charge.

Of course, the underlying investment expense is only part of the equation. Investors should consider the total cost of the relationship and the services they receive in return.

Low cost alone doesn't make an investment strategy good—but unnecessary cost doesn't make it better either.

Discipline and Ongoing Management

Building a portfolio is only the beginning.

Markets move. Asset classes perform differently. Portfolio allocations drift over time.

A professionally managed model provides an established process for monitoring the investments, rebalancing the portfolio, and making changes when appropriate.

It also removes some of the temptation to constantly change investments based on headlines, short-term performance, or emotion.

Good investing is often less about predicting what happens next and more about having a disciplined process when the unexpected inevitably happens.

What Is the Advisor's Role?

This may be the most important part of the discussion.

The advisor's job isn't simply to pick investments.

It's to determine which investment strategy is appropriate for the client in the first place.

How much risk should the client take? How does the portfolio support retirement income? Which accounts should withdrawals come from? Should the client be doing Roth conversions? How should taxable and retirement accounts be invested differently? What happens when markets decline right before retirement?

Those decisions require understanding the client's entire financial picture.

A model portfolio doesn't replace the financial advisor. It allows the advisor and investment manager to each focus on what they do best.

The Bottom Line

There is nothing inherently superior about an advisor personally selecting every investment in a portfolio.

The better question is whether the client is receiving a well-designed, diversified portfolio that is professionally managed, reasonably priced, and appropriate for his or her financial plan.

A quality model portfolio can accomplish all of those things.

For many investors, combining a dedicated investment management team with an advisor who understands their complete financial picture can be a very effective approach.

Ultimately, the goal shouldn't be to make investing look complicated.

The goal should be to build an investment strategy that is diversified, disciplined, cost-conscious, professionally managed, and connected to the client's financial plan.