Income planners take note: Madoff a cautionary tale

Kaplan says she believes it is a bad idea to diversify portfolio managers because no one is minding the “big picture.”

Jeremy Portnoff, an advisor with Portnoff Financial, Union, N.J., notes that diversification comes in many forms. One example is coverage by the Federal Deposit Insurance Corporation, Washington, D.C., and SIPC. “I never thought would be important to discuss (such coverage) with clients until now,” he says. Portnoff also cites tax diversification, and fund diversification such as having 2 funds in an asset class like an actively managed and index fund or exchange traded fund. Using a strategic asset allocation portfolio along with a tactical portfolio manager would provide diversification, he adds.

Dylan Ross, an advisor with Swan Financial Planning, East Windsor, N.J., says if a portfolio is not matching the market, then more diversification is needed. “Any over- or underweighting of a company, industry, or sector, amounts to a bet that has equal chances of being right or wrong he observes, adding that “investing costs make the financial consequences slightly worse for being wrong than the reward for being right.”

“A common misconception,” according to Ross, is that multiple bets diversify away risk but in reality, “the more bets one makes, the more of these negative-sum games they are participating in; therefore, they have a greater their likelihood of under-performance.”

Professional family offices and wealth managers already diversify client assets but the practice can also make sense for smaller clients, according to Bedda D’Angelo, president with Fiduciary Solutions, Durham, N.C. If, for instance, a client has 401(k) money with one mutual fund company, then D’Angelo will not put other assets outside of the 401(k) with that same fund family.

While diversification can be useful, it “is not the answer to everything,” according to Tom Davison, a financial advisor with Summit Financial Strategies, Columbus, Ohio. In some cases, it is used when there is poor risk control such as limited visibility into what is being done with client funds, he explains. “You can say that’s diversification, but purely driven by the fact you don’t (or can’t) know what you are doing–or at least not fully.”

Diversification can add complexity to a portfolio, he continues. However, it is useful when it reduces risk by introducing assets that have low correlation, Davison adds.

That depends on how it is executed, he explains. For example, while buying the same type of index fund from 2 providers is not useful, buying 2 funds with different investment philosophies can be helpful, according to Davison.

The question of whether the definition of diversification should be broadened to include clients’ diversification of financial planners meets with differing views.

For instance, Summit Financial Strategies’ Davison maintains that “getting a second opinion in the investment world is healthy. So is getting a second opinion in the financial planning world.”

But Kaplan of Kaplan Financial Advisors says that a second opinion is not a good idea unless the client is unhappy with the first advisor and is planning on making a switch. She asserts that “people got into trouble with Bernie Madoff not because they were working with one person, but because that one person was a ‘black box’ with no accountability and all the tools to deceive.”

Several financial advisors note that a financial planner is part of a team effort and works best when the team works well together.

Maas Capital Advisors’ Corbeau says that he has been asked only once or twice to opine on another planner’s work and that in general, as long as a team of allied professionals works well together, “the opportunities for ‘screw-ups’ are limited.”

More frequently, he continues, he is asked to provide a second opinion on investment strategies as a prelude to becoming the client’s advisor. In these cases, he says, since he strongly believes in asset allocation, a client has to buy in 100% with this philosophy

Fiduciary Solutions’ D’Angelo also believes in the financial planning team approach. “You can’t have 2 people working the same position on a team,” he adds. “They just trip over one another and nothing gets done.” When 1 of the team of financial professionals insists on being the quarterback for the financial team, then “a turf war erupts at the client’s expense.”

She says she does not include an insurance agent on the team, because “insurance agents usually attempt to take over the case to sell their own products and are unwilling to wait their turn at bat.”

But it is appropriate to seek a second opinion from an advisor as long as that advisor is qualified, D’Angelo continues. “The operative word here is ‘qualified.’ A stock broker is not a money manager, a money manager is not an insurance agent, and a CPA is not an attorney. All have biases. If you seek a second opinion, it should be from an advisor that performs substantially similar services and maintains identical professional credentials.”

Portnoff of Portnoff Financial, says that having more than 1 planner “might be cost prohibitive and confusing for the individual if conflicting advice is given. It might not be a bad idea, however, to have a second financial advisor that is contracted on perhaps an hourly basis just simply to review what is being recommended in order to validate what the client is doing and possibility look for any red flags or missed items. “That could be reasonable in terms of cost.”

Baron Financial’s Benante differentiates between getting a second opinion which he says can be a good idea and hiring multiple advisors which he maintains is not.

Hiring more than 1 advisor can result in “inconsistent or fragmented services” leaving the client with advice that is too conservative or too aggressive, as well as creating the dilemma of how to coordinate conflicting advice and what portion of a client’s assets will be given to each advisor.