Last Updated Jul 9, 2009 10:22 AM EDT
At a seminar I gave recently, I talked about the benefits of diversification. I explained that diversification is the only free lunch because proper diversification reduces, or even eliminates, unsystematic risks without reducing the expected return. At the end of the seminar I was asked: "If diversification makes sense, shouldn't you diversify your advisors as well?"
The short answer is no, but to understand why, it's important to differentiate among the three types of advisors -- money managers, investment advisors and financial advisors.
There's an old saying in football that if you have two (or more) quarterbacks, you really have none. Your financial advisor serves as the quarterback on your financial services team, coordinating between your investment advisor and/or your money manager, your accountant, your insurance advisor and your attorney. And there is no need for more than one financial advisor, one quarterback.
Investment advisors only advise on the investment strategy -- developing the asset allocation plan, performing rebalancing and efficiently managing the portfolio for taxes. Just as there should be only one financial plan, there should be only one investment plan, designed to provide the highest odds of success given the risks you are willing to accept. Thus, there is no need for more than one investment advisor.
The need to diversify money managers depends on your investment strategy. If you invest in publicly available passively managed funds (such as index funds), there is no need to diversify managers because your risk level is determined by your asset allocation, not the choice of managers. On the other hand, if you're an active investor, it would be prudent to diversify the risks of a manager underperforming. Fortunately, there is no need to diversify manager risk because the academic literature is overwhelming that choosing active managers is far more likely to lead to underperformance.
On Wednesday, I'll discuss money managers in a little more detail.