Diversification has long been an effective strategy for managing risk in an investment portfolio. However, there’s a common misconception that working with multiple financial advisors also diversifies risk. Unfortunately, this strategy can have the opposite effect. In many cases, working with more than one advisor introduces additional risks to your investment strategy.
Risk #1: Lack of Coordination
Working with multiple financial advisors often results in uncoordinated investment decisions. If no one clearly assumes the role of quarterback for your overall investment strategy, 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% of investors who work with at least two advisors consider one advisor to be their primary advisor. However, more than half of respondents said their primary advisor didn’t know other advisors were also managing assets on their behalf (SSgA & Knowledge@Wharton, 2011).
Diversification has long been an effective strategy for managing risk in an investment portfolio. However, there’s a common misconception that working with multiple financial advisors also diversifies risk. Unfortunately, this strategy can have the opposite effect. In many cases, working with more than one advisor introduces additional risks to your investment strategy.
Risk #2: Unintended Tax Consequences
Except in certain types of accounts, paying taxes is the cost of a successful investment strategy. Trades that result in capital gains and distributions from your account can trigger an associated tax consequence. One of the benefits of working with an advisor is that they can help you find strategies to offset these gains and minimize your tax bill.
Unfortunately, working with multiple financial advisors makes it more difficult to take advantage of these opportunities. Even if each advisor incorporates tax planning into their investment approach, their efforts may be in vain if they’re not aware of what your other advisors are doing.
Risk #3: Excessively High Fees
Many fee-based financial advisors and investment strategies offer breakpoint discounts to attract more money. When these discounts are available, 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. As a result, you may end up paying excessive fees, which can eat away at your investment results over time.
Risk #4: Falling Short of Retirement Goals
One of the most significant risks of working with multiple financial advisors is an unsuitable asset allocation—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 can account for as much as 90 percent of a portfolio’s performance over time.
When two or more advisors are managing your money independently, your overall asset allocation may deviate significantly from your goals and risk tolerance. For example, each advisor may increase their allocation to a certain asset class at the same time. This can introduce concentration risk to your portfolio and lead to unnecessary losses if the asset class underperforms.
On the other hand, your advisors may cancel each other out with their investment decisions. If one advisor adds an investment as another sells it, the net result on your portfolio is negligible but you may still pay two transaction fees. Ultimately, these types of uncoordinated decisions can impede your progress towards your future retirement goals.
Working with Multiple Advisors Can Be Risky
“Don’t put all of your eggs in one basket” has become a cliché when it comes to investing, so it’s not surprising that this mantra often extends to the financial advisor decision. Unfortunately, advisor diversification doesn’t necessarily have the same benefits as portfolio diversification.
One solution is to work with a fiduciary financial advisor you can trust to oversee your entire financial picture. He or she can coordinate with your other advisors—for example, your CPA or estate planning attorney—to ensure everyone is acting in your best interest. This can help you avoid unnecessary risk and achieve your long-term financial goals.
The information reflected on this page are Baird expert opinions today and are subject to change. The information provided here has not taken into consideration the investment goals or needs of any specific investor and investors should not make any investment decisions based solely on this information. Past performance is not a guarantee of future results.