There has been a lot of hype recently about the need to provide clients with personalized portfolios. Almost all of it comes from firms that offer direct indexing tools.
They suggest that the general trend toward personalization that we see in the world today applies, or soon will apply, to portfolios. This suggestion conjures up an interaction like this:
Advisor: Hello, Mr. and Mrs. Smith. What can I do for you today?
Mr. Smith: Well, we’d like you to build us a 60/40 portfolio that reflects our unique personalities and lifestyle. Now, I know you’re an expert in this stuff, but we’ve talked about it and we have some thoughts.
Mrs. Smith: We like ETFs because they are more modern than mutual funds, but could you give us something that doesn’t include BlackRock or Vanguard? Everyone has those. We’d like something a little more exclusive. Could you use funds that no one has ever heard of? Or maybe some stocks from hot tech start-ups—you know—the next Google, maybe.
Mr. Smith: Oh, and could you hold the emerging markets? We’re not too crazy about all those little countries. Except Mexico and Costa Rica. We vacation there and would like to show our gratitude by upping our exposure.
Mrs. Smith: And could you sprinkle in some alternatives? We’re not sure we could hold our heads up at the country club if we didn’t have a dash of alts in the mix.
And so forth…
The hype-sters would have you believe that client preferences for personalization are so strong that ETFs and mutual funds could soon be a distant memory, and any advisor who doesn’t offer up portfolios with personality is signing his/her own death warrant.
The statistics on client preferences for personalization in the broader consumer market are quite compelling. A 2021 McKinsey & Co. report found that 76% of consumers are more likely to consider making purchases from brands that personalize. And 78% said they are more likely to refer their family and friends to these companies.
According to Twilio’s 2023 State of Personalization Report, 56% of consumers say they will become repeat buyers after a personalized experience, up 7 percentage points from 2022.
A Salesforce study, Fifth Edition State of the Connected Consumer, found that 56% of consumers agree with the statement, “I expect offers to always be personalized.” And 73% agree with the statement, “I expect companies to understand my unique needs and expectations.”
But it is too big a leap to suggest that because consumers prefer personalization, they will start waltzing through the doors of advisors’ offices with lists of portfolio customization preferences.
The reason is that clients rarely have well-defined ideas about what they want their portfolios to look like. That’s why they seek out advisors in the first place. In fact, they often have only the foggiest notion of their long-term goals and objectives, other than they don’t want to run out of money before they die. Advisors are valuable precisely because they help clients sort this out.
Clients want to be treated as humans with unique needs and they want their financial plans to reflect those needs. However, they are paying you to build the best portfolio to get them there.
And, indeed, there are situations where the ability to customize a portfolio to meet the unique needs of a client is important. These are usually situations that the advisor, rather than the client, will recognize. Examples include where the client:
- has a legacy position with large, imbedded gains.
- holds employer stock and should eliminate more exposure from their portfolio.
- could benefit from the tax loss harvesting capabilities offered by direct indexing.
- has very specific ESG values that they would like reflected in their portfolio.
Direct indexing is a capability that is perfectly suited for addressing these needs. It provides a level of flexibility that ETFs and mutual funds cannot. So, it is a useful tool. Maybe even an essential tool for advisors who want to provide a full range of portfolio options to their clients.
But it comes at a cost. Our firm offers both ETF portfolios and direct indexing services. The expense ratios on our globally diversified ETF portfolios range from 0.04% to 0.06%. We charge 0.35% for direct indexing portfolios. This disparity exists throughout the industry.
The added cost of direct indexing may well be worth it to a client with specialized needs. But personalization is not free.
Keep in mind, that when our investment committee builds a 60/40 ETF portfolio, it is the best version of that portfolio we know how to build. Any deviation from it would make it a worse portfolio, in our opinion. I’m sure other asset management firms would agree with that concept, if not with our particular rendering of the 60/40 portfolio.
So, there should always be a solid rationale when personalizing a portfolio. If someone wants to design their own sneakers online or order a venti green tea Frappuccino with two pumps of caramel, three espresso shots, topped with whipped cream and a caramel drizzle, that’s their business. But indulging client whims and fancies in portfolio construction is another matter.
The future is a tricky beast. Those who offer up predictions about it are, more often than not, bit in the backside for their trouble. But I’m going to go out on a limb here and speculate that ETFs, mutual funds, and the advisors who use them will be just fine in the years to come.
Advisors should consider adding direct indexing capabilities to their arsenal, but not because there is about to be a wave of clients who want designer portfolios. Clients are still looking to you to tell them how their portfolios should be built and when customization is appropriate.
Scott MacKillop is CEO of First Ascent Asset Management, a subsidiary of GeoWealth, LLC. First Ascent is a turnkey asset management platform that provides services to financial advisors and their clients on a flat-fee basis. He is an ambassador for the Institute for the Fiduciary Standard and a 47-year veteran of the financial services industry. He can be reached at [email protected].
