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The financial advisory business is like any other industry in that there are plenty of myths and misconceptions floating around. Some advisors, even highly successful ones, fall prey to these mix-ups, meaning avoidance and debunking are essential.
While myths abound in the advisory industry, some of the most pervasive involve portfolio construction. That’s potentially problematic because portfolio management is one of the primary reasons call on advisors and investment selection and management is one of the biggest reasons advisors get into the business in the first place.
So deep are portfolio construction myths, Fidelity outlines seven in a recently published e-book. Simply put, eight is a lot. Those issues include clients’ time horizons, appropriate fixed income allocations and the purported comfort of consensus, among others.
Time Isn’t On Everyone’s Side, Bonds Aren’t for All
For generations, the gold standard of portfolio construction was 60% equities and 40% bonds with allocations to the former dwindling and exposure to the latter increasing as clients neared and entered retirement.
That previously adored combination suffered through one of its worst years on record in 2022 as stocks and bonds fell in unison. Not surprisingly, that prompted speculation that 60/40 may be dead and corresponding obituaries were summarily penned. On the other hand, there’s optimism that there’s still utility in this form of portfolio composition.
60/40 woes get to the heart of several of the myths mentioned by Fidelity, including there’s just one optimal portfolio construction for all clients, similarity in bonds and the efficacy (or lack thereof) of one-size-fits-all approaches,
“Given the sheer number of investing options available today to investors and their advisors, the concept of an ideal portfolio is an attractive one. Similarly, broadly streamlining investing approaches across multiple clients might seem like the easy answer; however, varying levels of investor needs means a one-size-fits-all portfolio may miss out on tax-efficient investing strategies and income opportunities that can meet specific investor needs,” notes Fidelity.
The asset manager also brings up the issue of time horizons. In this case, Fidelity says the myth is that owing to the dynamic nature of financial markets, what worked during one investing regime is likely to work in another.
Obviously, that’s not the case. The coronavirus pandemic is a real time of this myth. Following the brief bear market in March/April 2020, advisors may have been inclined to load up some client portfolios on growth equities due to low interest rates and easy money policies. That worked, but in order to have maximized that benefit, advisors would have to have reduced those exposures early last year.
“Looking through a multi-horizon lens provides a disciplined framework to evaluate portfolio decisions. For example, there is significant potential to enhance portfolio performance by tilting exposures toward the major asset classes based on shifts in the business cycle,” adds Fidelity.
Busting Style Myths
Advisors and experienced investors know that beating equity benchmarks such as the S&P 500 is hard. Really hard. As such, market participants are inclined to evaluate any perceived advantage they can get, including overweight styles (growth, value, etc.) and size (large-, mid-, small-cap).
As Fidelity points out, there are other avenues for generating out-performance in equity portfolios, including moving beyond cap-weighted index strategies and over/under-weighting sectors.
“With fairly stable composition, sectors display clear patterns of volatility, and are imperfectly correlated to each other. Performance is cyclically related to the economic environment, with clear patterns of volatility during different business cycle phases. Investors and advisors can use these patterns to choose sectors based on risk tolerance and investment goals,” concludes Fidelity.
Bottom line: Advisors can effectively falling prey to these myths and others by focusing on two key points: Customization and personalization.
Related: Discovering Which Clients Are Right for Model Portfolios