When Diversification Fails

Key Takeaway: Diversification is often thought to yield better results in many aspects of life. With an investment portfolio, the concept is key. However, diversifying your advisors might lead to worse outcomes.

Diversification is a concept that will probably get more traction as interest rates stay higher. Higher interest rates affect different asset classes differently; therefore, being too concentrated in any asset class could lead to worse outcomes.

In portfolios, diversification may make sense. But it doesn’t necessarily make sense when hiring an advisor (whether financial, CPA, attorney, insurance, etc.). When retaining an advisor of any sort, hiring one (versus many) is often the best answer, which may seem counterintuitive to the principle of diversification for better outcomes.

“What we’ve got here is failure to communicate.” —The Captain in Cool Hand Luke (1967)

Seeking advice is about outsourcing knowledge you don’t have. In its best form, the advice sharpens your decision-making skills, with the advisor disseminating all the information in the world down to the few data points that apply to your situation so you can make an informed decision. I think of advisors as funnels; there are a lot of inputs that the end user doesn’t need to know, but the output needs to be narrowed and focused.

It would be natural to assume that the more you diversify your advice, the more information points you would have to make good decisions. This is true when thinking across disciplines (law, tax, investment, insurance, estate, etc.), but it’s not necessarily true when thinking inside the vertical of one discipline.

It’s important to note that I run into many people who have not filled out a good stable of advisors across disciplines; it is difficult to find the quality of advice you might want across many fields who all see themselves as unique and the lead in a client relationship. However, having advisors across disciplines fills a specific problem of making sure you can understand the long-term ramifications of short-term decisions. You need experts in many fields to get this information.

What is counterintuitive is that you don’t need many experts within each discipline (this is mostly true, as there are disciplines, like law, where you might need certain experts within the field to answer very specific questions).

I will use my profession as an example. People often believe they should spread their investments across multiple advisors so that they get “more” advice. However, the problem that quickly arises is that “more” is subjective and depends on the client knowing what to do with the information.

I often see that the advice is conflicting or, at best, overlapping. For example, you may have two or more financial advisors managing your money. They may invest the money similarly, meaning you might end up with a concentration in one asset class you are unaware of.

Or the advisors might have contradictory beliefs about the market and nullify each other— for example, what if one invests in small-cap stocks and one does not?

Or one advisor might make a trade that affects your tax return, and the other doesn’t know it, so they make a trade that also impacts your tax return.

What ends up happening is like the Cool Hand Luke quote above: There is a failure to communicate—and the failure affects you.

Consider the Why

Having multiple advisors is not just a financial planner’s problem. This could happen if you had multiple accountants, lawyers, insurance agents, etc. So take the term “financial planner” out of the equation and think more generically: Why are you hiring someone?

Whenever you retain a professional, you hire their process, people, and expertise. Usually, the best outcome occurs when you commit to that process, those people, and that expertise.

It is like remodeling a home; you interview many to narrow it down to one. You do this to make it easier to monitor progress, make decisions faster, reduce costs, save time, work with one person who understands what you need more comprehensively (personalization), and be more proactive because it is easier to understand what is happening.

That same reasoning applies to hiring a financial advisor, CPA, or lawyer. The crux of the issue is in the hiring process—what is your process of hiring these professionals? Hiring professionals is hard because the end user does not really understand what makes for a quality relationship over another.

One issue I see a lot is when a family has a lawyer who is a generalist and not a specialist in estate planning draft their estate plan. To many, a lawyer is a lawyer is a lawyer. And the same issue applies to financial planners. Some of us go way beyond investing and reach into tax planning, estate planning, retirement distribution, risk review, etc. The end user often thinks we all do it. Not true.

I have seen lists of questions to ask an advisor when hiring them, and in my opinion, these lists don’t uncover much. All of us need to get better at asking questions. The way to do that is to start with being inquisitive instead of assuming. Just play dumb. Ask anything and everything and see what the story is.

I like to ask questions that reveal how professionals think. For example, we all know whoever we hire is going to make a mistake. The mistake is one thing, but how they recover from the mistake is more important. So, I like to ask professionals to tell me about a mistake they have made with a client, what they did to fix it, and what they did to ensure it would not happen again with future clients. If they can answer that quickly and not defensively, it is obvious that they are thoughtful and care about giving good service.

Understanding the thought process is often as important as having the technical skills to deliver.

Try It Earlier

Often, people wait until they have a big event to think about how to find service professionals. Moments like selling a business, retiring, getting married, etc., are all significant, and the pressure is on to find the right advisor. Do yourself a favor and practice finding quality advisors earlier than that. If you strike out, you will have time to find a new one.

If you have questions or would like to learn more, contact Jon Meyer, CFP® at JMeyer@BGM360.com or send us a message.

Schedule a complimentary 30-minute introductory call with a fee-only financial advisor to discuss your personal situation.

The opinion of the author is subject to change without notice and must be considered in conjunction with relevant regulation, as well as subsequent changes in the marketplace. Any information from outside resources has been deemed to be reliable but has not necessarily been verified. Each individual has unique circumstances to which this information may or may not be relevant. Under no circumstances will this information constitute an offer to buy or sell and it does not indicate strategy suitability for any particular investor.