When to Use a Model Portfolio

What is a model portfolio and should you consider them? Adviser Keith Whitcomb explains how this growing trend may be the right fit for you.
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By Keith Whitcomb, RMA

While recently attending a virtual conference, I was surprised to hear one of the speakers talk about the advisor he used for his personal portfolio. Why surprise? Because he was an advisor! Based on his comments, it sounded like he found value in having a second set of eyes looking at his investments. So even if you are comfortable with investing, you may still want to seek out some supplemental professional guidance. And what should you look for? Well, it may make sense for you to find an advisor who is part of a growing trend that incorporates model portfolios into the financial planning process.

Keith Whitcomb

What’s a model portfolio?

According to Broadridge, “In their simplest form, model portfolios are a series of predefined asset allocation pie charts in which a recommended mix of different asset classes are proposed based on a client’s risk tolerance.” A Morningstar definition provides a little more insight: “Third-party model portfolios offer financial advisors an opportunity to outsource some, or all, of their investment management responsibilities… model portfolios can focus on a single asset class, such as equities or fixed income, but models usually combine multiple asset classes to meet a range of investor needs, including targeting a specific level of risk, providing income, and/or maximizing after-tax returns.” But haven’t we seen this before? Balanced Mutual Funds, Target Date Funds, ETFs, Robo Advisors… Are model portfolios actually new, or just a new marketing spin? While maybe not a new concept from an investing standpoint, model portfolios do signal a significant shift in the delivery of investment guidance from financial advisors.

Fading Out: The Investing Advisor

Traditionally, you would hire an advisor to build a portfolio from scratch. The advisor would research stocks and bonds, perhaps pursue a growth or value strategy and purchase on your behalf a diversified portfolio of investments that would be expected to outperform a benchmark. On an ongoing basis, your advisor would also rebalance the portfolio when necessary. Periodically you would meet with your advisor to listen to detailed stories of investments that did well and perhaps some that “under-performed”. You would learn about what would be bought and sold from the portfolio and why. It was all about the performance of individual investments and the portfolio.

Paradigm Shift

In the words of Bob Dillion: The Times They Are A-Changin’. Local and regional advisory firms are now realizing that building portfolios is a commodity business dominated by huge players in the financial services marketplace that have large budgets for staffing and research. In addition, market access has been democratized (everyone can now trade online with an app on their phone), and fees associated with funds of all types have been dropping, some to $0. While perhaps older high net worth clients and young adults in their early accumulation years are still interested in stock picking (or crypto currency) war stories, the majority of individuals approaching or in retirement are far more interested in income/decumulation planning. Model portfolios give financial advisors a solution that frees up time they previously dedicated to portfolio construction and maintenance to instead address your unique financial issues and/or cash flow needs. Model portfolios also do it in a way that is flexible enough to allow for the creation of individualized investment solutions in an efficient and cost-effective manner.

Fees

When it comes to understanding fees, figuring out what you pay for financial products and services is always a challenge. Hiring a financial advisor who uses model portfolios is no different. The cost associated with a model portfolio strategy will ultimately be incorporated into the fees you pay to your Advisor. Will it be cheaper? Maybe. Depending on the products used in the underlying model and how the outsourcing of the portfolio management process reduces your Advisor’s operating expenses will likely determine whether your fees will go up or down. The take away here is to shop around as “your mileage will vary”.

Summary

If you want a stock picker, then an advisor who uses a model is not for you. In addition, Robo and target date alternatives are likely fine during your accumulation years if your savings goals are relatively straight forward. However, if you want something more than just a portfolio builder, look for an advisor that offloads that function in order to better serve your individual financial needs. As you approach retirement in your 50s or need to harvest your savings for retirement income, a more full-service advisor who can plan out decumulation strategies will become increasingly important. Hiring an advisor who uses a model portfolio may be your best option.

About the author – Keith Whitcomb, RMA®

Keith Whitcomb, MBA, RMA®, is the director of analytics at PERKY and has more than 20 years of institutional investment experience. He is Series 6, 63, and 65 licensed.