Littlejohn: The pitfalls of working with multiple investment advisers

Brian R. Littlejohn
It's Your Money
Guest Commentary
The Aspen Times

Diversification can be an effective tool for managing risk in an investment portfolio.

However, there’s a common misconception that working with multiple investment advisers at the same time also reduces risk. Unfortunately, this strategy can backfire and have quite the opposite effect. In many cases, working with more than one adviser introduces additional risks to the success of your investment strategy:

Risk No. 1: Lack of Coordination

Working with multiple investment advisers 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 within your portfolio.

Even if you designate a primary adviser, problems can occur. One study conducted by State Street and The Wharton School of the University of Pennsylvania found that 65% of investors who work with at least two advisers consider one adviser to be their primary one. However, more than 50% of those investors then said that their primary adviser didn’t know that other advisers were also managing assets on their behalf. This type of arrangement increases the odds of the investor bearing an unsuitable level of overall risk because the primary advisors have no visibility into what the secondary advisers are doing.  

Risk No. 2: Unintended Tax Consequences

Except in tax advantaged accounts, like IRAs and 401(k)s, paying taxes is the cost of a successful investment strategy. Realized capital gains, interest, and dividends received within accounts that aren’t tax advantaged usually trigger an associated tax consequence. One of the benefits of working with an adviser is that they can help you employ strategies to offset these taxable events and minimize your tax bill.

Unfortunately, working with multiple investment advisers makes it more difficult to take advantage of these opportunities. Even if each adviser incorporates sound tax planning into their investment approach, their efforts may turn out to be in vain if they’re not aware of what your other advisers are doing.

Risk No. 3: Excessively High Fees

Many investment advisers that charge AUM (assets under management) fees use a tiered fee structure as a way of providing clients with a volume discount of sorts. 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 investment advisers, you may miss out on these discounts. As a result, you may end up paying excessive fees, which can eat away at your investment results over time.

Risk No. 4: Falling Short of Financial Goals

One of the most significant risks of working with multiple investment advisers is an inappropriate 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 advisers are managing your money independently, your overall asset allocation may deviate significantly from your optimal asset allocation. For example, each adviser may decide to 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 happens to underperform.

On the other hand, your advisers may end up cancelling each other out with their investment decisions. If one adviser adds an investment as another sells it, the net effect on your portfolio is negligible but you may still have to pay two transaction fees. Ultimately, these types of uncoordinated decisions can lower your returns and impede your progress towards your goals.

Working with Multiple Advisers Is 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 investment adviser decision. Unfortunately, adviser diversification isn’t likely to confer the same benefits as portfolio diversification.

One possible solution is to work with an adviser who is well-versed in both financial planning and investment management to oversee your entire financial picture. He or she can then coordinate with your other advisers — for example, your tax professional or estate-planning attorney — to ensure everyone is acting in your best interest. This type of arrangement can help you avoid unnecessary risks and achieve your long-term financial goals.

Brian R. Littlejohn, MBA, CFP®, CFA is the founder of Sherwood Wealth Management, an independent, registered investment advisor (RIA) firm that specializes in inherited wealth. He lives in Woody Creek and works with clients in the Roaring Fork Valley and beyond.