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The Future of Advice

Investment strategies tailored to your unique goals and needs - not just trying to “beat the market”

Introduction

Financial advice is broken.

Every firm claims to offer personalized financial planning and investments. 

But here’s the catch: They all follow the same outdated investment strategy that leads to a failure in the one thing our profession is sworn to do: Help you achieve your financial goals.

I want to break down the three major flaws we see across the industry… 

  1. Risk scores
  2. Model portfolios
  3. Focusing on the wrong objective

But, more importantly, I want to show you how we can fix the broken system.

Risk Scores

Risk scores at their most basic say:

“How much risk can you tolerate? A lot? Great. More stocks.”

Or

“How much risk can you tolerate? Very little? Ooh. Less stocks.”

I’m oversimplifying, but you get the idea – the more risk you can tolerate, the more an advisor is willing to introduce you to volatile investments, because there’s a greater upside, and you aren’t as worried about the downside.

In theory, pretty solid.

But in practice, we think they’re crap… here’s why:

You’re more than just a number

Consider the following excerpt from our article dedicated to the topic, Going Beyond Risk Scores to Reinvent Retail Investing:

“Risk surveys are a norm when it comes to investment advice. They may vary in content and length, but their common purpose is to distill an investor’s complex profile into a single measure of how much risk their portfolio should assume. Inputs include age, wealth, income, investment horizon, and investor behavior. The resulting measure, either qualitative (‘conservative,’ ‘aggressive’) or quantitative (‘6 out of 10’), is meant to be reductive enough so as to be interpreted by the person or the algorithm building the portfolio. It ultimately determines the target volatility constraint inputted in a portfolio optimizer function.”1

That was jargon-y, so here’s the abridged version:

Risk scores try to condense everything about you into a single measurement – if you’re lucky it’s a 10-point scale, if you’re unlucky it’s like flipping a switch between ‘conservative’ and ‘aggressive’ – so that an advisor can slot you into one of the handful of pre-made portfolios they use for everybody.

They’re subjective and unscientific

Classifications like “conservative, balanced, aggressive” are completely arbitrary and convey a false sense of alignment between the investor and their investment strategy. 

What could be risky to you might easily be considered safe for another investor.

It’s like a doctor asking you for medical advice

Let’s say you were just diagnosed with cancer.

Then, when the deafening buzz and blinding lights finally clear from your head, your doctor asks you:

“On a scale of 1 to 10, how do you feel about chemotherapy, and how much would you like?”

Your first thought might be, “the least amount of poison needed to kill the disease, please.”

But it’s more likely to be, “wait, shouldn’t you know how much chemo I need?”

Risk scores are functionally the same.

Instead of the advisor asking about your personal, financial, and family goals, and then crafting a strategy to fit your unique needs, they take a data point about your emotions at a given point in time, and then match that to a plan that may – but probably won’t – set you on target to meet your goals.

“The market took a big hit so I’m a little hesitant about stocks today” has no bearing on “I want to retire in 10 years with enough money to maintain my current lifestyle.”

So why do most financial firms use them?

We’ve got three guesses:

  1. Scalability: If an advisor can grab one number from you and match you to a one-size-fits-all portfolio, then they can do the same for every other client. Wala, operational efficiency… potentially at the expense of your retirement.
  2. Scapegoating: When cookie-cutter investment recommendations fail to reach your goals, it’s easy to point at your chosen risk tolerance as the culprit – not the portfolio they dropped you in or the advisor themselves.
  3. Regulations: Many of the largest firms have lobbied against a uniform fiduciary standard for advisors. While there are many reasons for this, none of them are in your best interest. It all comes back to profit margins and being able to mass-produce financial products, then your risk score is used to justify to regulators why you were matched with a portfolio that failed to meet your objectives.

For a detailed analysis of the failings of risk scores, I would encourage you to read our article, Going Beyond Risk Scores to Reinvent Retail Investing.

Model Portfolios

We talked about cookie-cutter investment strategies above.

The chief among them is the Model Portfolio.

Here’s the common 3-step process firms use to create these portfolios:

Step 1: Group individual investments into somewhat arbitrary groups and sub-groups. Often done by asset class, company size, geography, sector, growth profile, etc.

Step 2: Then select money managers (mutual funds and ETFs) in each of the groups. The managers select the individual investments with the goals of following their investment mandate and outperforming their respective benchmarks (read: not your benchmarks).

Step 3: Finally, they’ll set some basic trading rules like rebalancing frequency, drift tolerances, and other jargon designed to keep you from asking questions about what’s going on.

The end result? The Ford Model-T of investing – a static model portfolio that can be mass-produced to as many clients as possible, without any additional work or cost.

But model portfolios come with three big-time assumptions:

  1. A firm or person can guess the right risk loading into each pre-set group based on your risk score.
  2. A firm or person can pick the right managers for each group.
  3. The money managers selected can continually hand-select the right individual securities.

What’s so wrong about those assumptions? A couple things.

Assumption #1 falls prey to what we talked about earlier – that risk loading is dependent on a single number that tells an advisor how you felt about “risk” during one meeting, on one day of your life.

Assumptions #2 and #3 suffer from the same problem as retirees that want to “go it alone” – individuals, even experts, fail time and time again to beat a market benchmark. It’s not impossible, but you better hope that those money managers carry around enough horseshoes and rabbit-tails to give them the luck needed.2,3

On top of those assumptions, there are three questions you should ask yourself about model portfolios:

  1. Where during the process do my unique financial and life goals come into consideration?
  2. What incentive drives the firm or advisor who creates the model portfolio?
  3. Is it likely that the incentives driving the money managers are aligned with my unique objectives?

I’m about to make an assumption of my own, so bear with me:

The “official” objective of model portfolios is to follow an investment mandate or outperform a specific benchmark.

The “real” objective of model portfolios is to make your unique situation (along with thousands of other unique situations) fit into a standardized category so that your advisor, the firm, and the industry can have a more scalable and profitable business model – regardless of what happens with your retirement.

We’ve been going for a while, so if you’re still with me, thank you – and I’ll try to keep this last section as brief as possible.

The Wrong Objective

Let’s start with a quote from Robert C. Merton, a Nobel laureate and professor at the MIT Sloan School of Management:

“Investment value and asset volatility are simply the wrong measures if your goal is to obtain a particular future income.” 4

The overwhelming majority of firms focus on arbitrary benchmarks and historical returns. But you should have a dynamic investment strategy focused on one thing: Achieving your financial plan and living the life you want. Not focused on beating an arbitrary benchmark or “asset value maximization” – objectives that often conflict directly with your primary goal.

Traditional investment methods are obsolete and fail to deliver the results that you need. So we said goodbye to them…

The Lifeworks Innovation

We set out to build the future of financial advice: A framework that provides dynamic investment strategies, hyper-personalized to your specific needs and goals.

It’s built on three easy-to-understand pillars, without all the jargon: A liability-driven investment strategy, factor-based investing, and smart beta.

A Liability-Driven Investment Strategy

For years, pension funds (designed to provide a stable, consistent income in retirement) have been using a liability-driven investment strategy.

The idea is simple: Determine the money you need in the future (“liabilities”), and invest in the assets with the highest probability of paying out those benefits when needed.

No arbitrary benchmarks. We match the right investment assets to your specific cash flow needs (liabilities) with the proper risk loading.

Our investment strategy is dynamic and adjusts to changes in your financial plan and the market. For a more detailed description of our methodology, check out From Investment Products to Investment Solutions.

Factor-Based Investing

We leverage about a dozen factors (some that influence all asset classes, and others that influence specific ones), which allows us to:

  • Create hyper-personalized portfolios that allocate investments based on scientific risk factors instead of arbitrary asset classes.
  • Eliminate the expenses of active management (fund fees and manager fees) and provide superior liquidity.
  • Provide total customization of each portfolio to align with your values and financial goals.
  • Allow complete control of taxes and tax-planning opportunities.

Smart Beta

A combination of active and passive investment frameworks that provide complete transparency into investment frameworks, provide true diversification, and provide more consistent long-term returns than market-cap-weighted portfolios and indexes… at the price of passive investments.

We’ve built a strategy that relegates risk scores and model portfolios to the ash heap of history.

Contents

Footnotes

  1. Mathé-Cathala, Alex. “Going Beyond Risk Scores.” Lifeworks Advisors, 2020.
  2. Bu, Qiang and Lacey, Nelson. “Reexamining Fund Manager Skill From a New Angle.” Managerial Finance 42, 2014, revised in 2020.
  3. Clare, Andrew. “The Performance of Long-Serving Fund Managers.” Available at SSRN: https://ssrn.com/abstract=2836434, 2016.
  4. Merton, Robert C. “The Crisis in Retirement Planning.” Harvard Business Review, vol. 1401, 2014
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