I’ve been in the investment advising business for almost six years now. During that time, my role in this business changed. I started as an office assistant and learned the ropes for 2 years.
Since then I’ve been in charge of other people’s money. Sometimes it’s someone’s brokerage account that they have with me to diversify among financial institutions.
Sometimes it’s someone’s life savings.
Obviously, when I started, I was in charge of very little until I gained enough experience and was able to prove myself as a capable advisor and investor.
From then until now, my investment philosophy changed. How I view investing and my approach to managing clients’ money is different from when I started.
When I started
In the beginning, it was very straight forward. I was a value stock picker. I charged a 1% fee (industry average) for that service, but the client also got unlimited access to me during business hours and other financial planning services.
Then I figured out, picking stocks was not a good use of my time. The research and analysis took far too long, and my time could be better spent engaging with clients and prospects.
I changed my method of doing business. Instead of picking stocks, I would utilize passive ETFs. Because I was not putting in as much time with client accounts, I charged them less. It seemed fair and logical.
I still offered the same “extra” services, but I didn’t have to spend nearly as much time researching stocks. Instead, I had a basket of investment options to pick from and would allocate clients’ portfolios according to their age, risk tolerance, and time horizon.
Don’t get me wrong, I still believed in active management, but being able to do that and grow my book of business was extremely difficult.
Yeah…passive has outperformed active for the last decade (source). That’s because we haven’t had anything to, really, panic about. Since the Great Financial Crisis, the market has been up and to the right with minimum volatility. Certainly, well below average (source).
I thought low fees and passive ETFs were going to be the way forward.
My mind was blown
That was until I watched a video on Real Vision. In the video, the guest being interviewed brought to attention the danger of passive ETFs.
He explained that once passive overtook active, in terms of net assets, we’re in trouble.
And it began to make sense. ETF custodians (Blackrock, for instance) need to sell underlying securities when investors sell the ETF. They don’t have a significant amount of cash on the side at the ready for redemptions.
The lightbulb came on. When the market actually crashes and we experience a recession, there’s going to be a barrage of selling. Everyone is going to try and get out of the market and minimize the damage.
That’s the problem. If half of investors are in passive funds, then those funds will have to sell loads and loads of securities to meet client demands.
Selling will exacerbate and the sell-off will intensify until we have a 1987 type moment. Thankfully, there are “circuit breakers” now in place.
What’s a circuit breaker?
If the S&P 500 index falls enough, trading will halt. There are three levels of circuit breakers. Level 1 is a fall of 7% and trading halts for 15 minutes. Level 2 is a fall of 13% and, again, trading halts for 15 minutes. Level 3 is a fall of 20% and trading ceases for the remainder of the day.
After that video, my philosophy shifted. Instead of utilizing passive funds, I use active and smart-beta ETFs. I get the best of both worlds. Active management and low fees.
What’s the point?
I wanted to make two points when writing this.
- I wanted to highlight my thought process, my investment philosophy, and how it changed.
- I needed to get across an important message. One that we seem resistant to. You HAVE to be willing to adapt. To change. Not only that, you have to challenge your own ideas.
I’ve made two changes in my process so far and I hope there are more changes coming, but those changes didn’t happen overnight.
I poured over hours of research, reports, and charts. I needed to make sure that the change I made would benefit my clients.
One last thing I wanted to mention. When my philosophy changes, I don’t make sweeping changes to my clients’ portfolios.
That would a) be incredibly annoying as a client to have your portfolio transform because my ideas changed, and b) selling and buying could incur fees and taxes. Clients shouldn’t be penalized for that.