If done properly, diversification reduces risk in a portfolio and potentially generates a higher rate of return. But there is one type of diversification that does not fit with an investment plan.
I’ve already written about several bizarre investment strategies that physicians use in my past few articles. (Part 1, Part 2, and Part 3.) These are real examples from retirement portfolios I've reviewed.
You’ve probably heard of a concept called diversification. In investment portfolio management it refers to spreading out your risk by owning multiple securities within an asset class and also owning multiple asset classes. If done properly, you can reduce risk in a portfolio and might be able to generate a higher return per unit of risk than a less-diversified portfolio.
But there is one type of diversification that doesn’t really fit with an overall investment plan.
Recently, I reviewed a physician’s portfolio and noticed that he had a huge number of holdings—around 50-plus mutual funds, 20-plus exchange traded funds, and 100-plus individual stocks. These were spread out across more than 15 different accounts and 5 different institutions.
The physician didn’t trust a single financial advisor to help him manage his $1 million portfolio—instead, he spread out his portfolio across 5 advisors thinking that if one doesn’t do well, then surely another one will. Or if one turns out to be a fraudster then, hopefully, the others won’t be.
The problem is that the first advisor doesn’t know what the second one is doing, the second advisor doesn’t know what the first or third one is doing, and so on. The primary drivers of your investment returns are risk and asset allocation. By using multiple advisors, each of whom have different investment philosophies and strategies, you don’t know how much risk you’re taking across your entire portfolio, and you lose control of your asset allocation.
The right way to manage your investment portfolio—whether you do it yourself or hire an advisor—is to make all pieces of the puzzle (the different accounts and funds) fit together into a holistic unit. While you can’t necessarily combine different types of accounts like 401(k) and taxable account together into one, each account still needs to “talk” to the next and fit with that account.
Bottom line is that this physician didn’t have an investment plan. It was chaos. And he was wasting his money. If you’re portfolio looks similar, either fire all of these advisors and do it yourself, or choose one to develop a holistic investment plan for you, consolidate accounts, and simplify your life.
Many physicians think that because they're making 6-figure incomes, they need more complexity in their finances and investments. Or they think that somehow more complexity in your retirement portfolio can generate better returns. While some additional complexity (assuming it's the right type) may make sense, having lots of different advisors managing bits and pieces of your retirement portfolio makes no sense.