Principal Involvement

Accepted wisdom says that no one cares more about your money than you. In the case of most of the people I work with, this is true. There are, however, a few people whom I feel take very little responsibility for their finances. Whether they have no interest or no capacity or simply find it distasteful, they benefit from having someone handle their investments on their behalf. The majority of people, however, do well to be involved in the decisions that are made about their finances.

It’s important to understand what’s going on with your investments. Your advisor is held accountable by having to explain to you his recommendations and his reasoning. Further, there is no guarantee that an individual will remain with the same advisor. Whether the advisor retires or the investor moves, continuity will be provided by an investor who understands their own strategy and their own investments. An informed investor can also ask pertinent questions that might arise from their own specific situation. For example, a person who plans to take a sabbatical may have different savings, income and tax planning needs to be accommodated.

The more layers of management that exist between an investor and their money, the less understanding and control there can be. As an example, an investor who owns a portfolio of individual stocks and bonds, which are visible on their statements, can easily understand what they own. They can see their strategy in practice and they can ask any questions that arise about their holdings. A different investor who invests in a fund of funds doesn’t benefit from the same level of transparency. Mutual funds only report their top holdings, and only update this information quarterly. It also may be difficult to reconcile the strategy of each individual manager with the process of the manager of the fund of funds to ensure there is minimal overlap or overlay. Transparency simply doesn’t exist to the same degree.

It is common, in the investment industry, to structure financial incentives as a facet of pooled investment funds. Investment managers, I presume, want to be rewarded for the value that they provide when they outperform the market. The first problem is that investment managers have only incomplete control over their results. Secondly, research has shown that financial incentives are ineffective. The most successful people are the ones who work doing what they love and are continually trying to improve themselves. From this perspective, there is little benefit to adding layers of management, since great investment managers will do their best work, regardless of who the investors are.

Finally, working directly with an investment manager allows the opportunity to have the type of relationship where they would feel ashamed to let you down. Knowing who they are working and are going to be accountable to may cause an investment manager to consider their decisions differently. They will understand the needs and hopes of their beneficiaries of their work, and they will take seriously their responsibility to those people.

Adding layers of management doesn’t, in and of itself, cause problems. It does, however, reduce the likelihood of benefiting from a firm understanding of one’s own strategy and how it is being implemented. It also removes the personal relationship between the investor and her investment manager, a relationship which should encourage heightened accountability. It also increases the likelihood that financial incentives will be introduced in an effort to manipulate the choices of a decision-maker who is removed from the principal. The more involved an investor remains with his or her investments, the more robust the process is likely to be.


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