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A DFA Devotee Says Type of Advice More Valuable Than Type of Portfolio

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Eric Nelson is one of those rare advisor’s advisors. Apart from keeping up with academic financial research, he will sit down with his Windows-based statistical program to perform a three-factor regression analysis to determine where a mutual fund adds value.

By publishing such analyses on his blog, RealClearMarkets or Amazon Money&Markets, he offers other advisors — and high-net-worth investors — insight on the narrow crossroads where investment theory meets the financial products that advisors use.

While Nelson’s research has led him firmly in the DFA direction recently — he used to use a mix of Dimensional Fund Advisors and Vanguard products, but is now 100% in the DFA camp — Nelson insists that working with the exclusive fund company is not the principal source of value he offers clients.

“At the end of the day, DFA is just a tool,” he tells ThinkAdvisor in a phone interview. “There’s probably an added 1% in higher returns I can bring to my clients using DFA funds. But that’s not as big as the 2%-3% a year investors are [routinely] losing by doing the wrong thing” through actively managed funds and undisciplined investing.

And that is the topic — where an advisor really adds value, and where they all too often let down their clients — that Nelson wanted to address.

“An area that frustrates me is you have one segment of the advisory industry that struggles to communicate their value, so all they do is they slash their fees to bargain basement levels. And clients don’t know what they own and don’t stay with it.

“On the other side, there are advisors who provide abstract planning elements, but there’s only so much time in a day to meet with clients. When things get tough, they’re more likely to bail at the wrong time.”

The result, he says, was 2008 — specifically all the fearful investors who sold at the wrong time.

“From the perspective of someone who worked with an advisor who didn’t spend time to help the client understand why his portfolio was right for the long term—[2008] was the advisors’ fault, [clients] not knowing what they owned, so they sold.”

The principal of Oklahoma City-based Servo Wealth Management says he makes sure to take the time necessary to ensure clients do not obey any destructive instincts they might have.

The boutique firm serves about 25 affluent clients — nearly half outside of Oklahoma — with about $50 million in assets. Nelson’s goal is to have 100 clients with $250 million in assets over the next 5 to 10 years. He does not want to have more clients than he feels he can properly manage.

“I use six or seven core broad asset classes. That’s enough to get meaningful diversification,” he says, but not so much that it undermines clients’ understanding of what they own.

Investment management is mainly about “having a portfolio that actually achieves what they’re trying to accomplish and making sure the client doesn’t screw it up,” he says, adding that knee-jerk selling and chasing investment performance are the two destructive paths investors pursue when they are not properly counseled.

So while intelligent investment analysis and deep product knowledge are of value, the advisor’s key added value is simpler, and less tangible, than those.

“My biggest criticism of the industry is that [few] advisors really look at that as being their primary responsibility … Everybody [instead] says they can time the market or pick winning managers or are the first kid on the block with some hot new asset class.

“But the real value is sort of intangible—providing an appropriate portfolio and being disciplined is hard to quantify; it’s hard to measure the value of not behaving badly.

“But for clients who’ve experienced that, who have stayed with a plan when their knee-jerk response was to do something different, they appreciate that value.”

The fee-only RIA must be doing something right; he says half the growth of his firm stems from referrals from existing clients and the other half from people who read his blog posts and published articles.  Many of those prospective clients cite bad experiences they’ve had with other advisors who may have overpromised but underdelivered.

“It’s such a competitive industry,” Nelson says, “and it’s so hard to explain in an introductory meeting what value I provide. It often defaults to ‘I can beat the market’ or ‘I’m smarter than everyone else.’ That’s the predominant message. It’s completely wrong. It’s a farce.”

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