The way advisors manage money looks much different than it did 20 years ago. In the past, they often relied on off-the-shelf ETFs, proprietary mutual funds, or funds of funds to help client’s reach their goals. But today, thanks to advances in technology, advisors have access to tools and software that deliver a more personalized and efficient investment experience.
One of those is the ability to build custom portfolios with single securities. By directly owning individual assets, rather than indirectly through an ETF or mutual fund, advisors can unlock a handful of benefits that were otherwise out of reach—including personalization, value-based screening, tax savings, and cost controls.
For a long time, ETFs and mutual funds were considered the key building blocks of a diversified portfolio, but these investments, in all their varieties, always left something to be desired: customization. Advisors have unique clients with unique needs and unique values that don’t fit neatly into a box. We think they can address this shortcoming by using single single securities.
The two most popular ways of doing so are custom and direct indexing. Both approaches rest on the idea that directly owning individual securities in a separately managed account (SMA) can do more for clients than a portfolio of ETFs and mutual funds. By doing so, clients receive all the diversification benefits of an index fund but with the flexibility to accommodate their risks and needs.
Clients may be asking why this wasn’t available before? Well it had always been available for high and ultra high net worth individuals who could afford to pay for these services. But recent innovations in trading technology made it easier for advisors to create custom portfolios of single securities for anyone. Chief among these breakthroughs are commission-free trades, fractional shares, and improved data infrastructure.
A client’s financial situation is the sum of many moving parts: their goals, career, marital status, health, family’s health, etc. Each piece looks different from one person to the next. So it makes sense that their portfolios do as well. By investing in individual securities, an advisor can target specific holdings that fit their client’s goals and risk factors. Suppose a client was granted stock options from an employer. A portion of their wealth already rides on this one stock, and in the event the price plunges, it would put their goals in jeopardy. Advisors can now remove those names from a client’s portfolio without removing any potential sources of uncorrelated returns or derailing their client's financial plans.
Investing is not just about finances, but values too. Advisors may have clients who want to restrict coal producers or fossil fuels companies from their portfolio, or perhaps a client is looking for ways to align their money with their religious beliefs. It’d be difficult to do either with an off-the-shelf ETF or mutual fund. Even existing value based funds can only do so much. Many of them have lax screening methodologies that often let troublesome names sneak into the fund. With a custom single-security portfolio, however, an advisor can create custom screens of individual securities based on ESG, religious beliefs, or anything else their client values.
Investing in single securities unlocks a handful of tax savings, the biggest being tax-loss harvesting. Tax-loss harvesting at the security level let advisors be more precise in what gains and losses they harvest and avoid potential wash sale issues. Research shows that this process may yield 1% in tax alpha each year.
Owning an ETF or mutual fund comes with various fees, including expense ratios (both), loads (mutual funds only), and 12b-1 fees (mutual funds only), amongst more. Although the fees may seem small on their own, the costs add up when you own multiple funds. Advisors can reduce some of these costs by investing in single securities, which do not charge a fee for buying and selling.
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Monte Carlo simulations have material limitations. Market movements may be more or less extreme and more or less frequent than those that occur in the model. Certain asset classes and investments have shorter histories than others and may not be as reliable. Market Events and other factors may influence the reliability of the potential outcomes.
All investment strategies have the potential or profit or loss. Changes in investment strategies, contributions or withdrawals, and economic conditions, may materially alter the performance of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will either be suitable or profitable for a client’s portfolio. There are no assurances that the portfolio will match or outperform any particular benchmark.
Back-tested performance results have inherent limitations, particularly in the fact that these results do not represent actual trading and may not reflect the impact that material economic and market factors might have placed on the advisor’s decision-making if the advisor were actually managing the clients’ money.
Nothing provided herein constitutes tax advice. Individuals should seek the advise of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or any other jurisdiction.