Saturday, March 8, 2014

Nonprofit Investment Counsel Using Students ... A Good Idea?

While many commentators observe that portfolio management is becoming commoditized, there remains a need for due diligence and portfolio design and maintenance. There are far too many ways to mess up in the world of investing. And just one mistake can significantly affect an individual investor's retirement security or the achievement of their financial and life goals.

The following list of opportunistic strategies and potential mistakes is from a book I wrote in 2003, The Science of Investing:

Eight Strategies That Will Aid You In Achieving Your Long Term Goals

  1. Invest Part of Your Portfolio In Stocks To Counter The Risks Posed By Inflation
  2. Pay Attention To Bond Credit Quality
  3. Invest Part of Your Portfolio In Value Stocks To Enhance Returns
  4. Keep Bond Maturities At Reasonable Levels
  5. Invest Part of Your Portfolio In Small Company Stocks To Enhance Returns
  6. Create and Adhere To An Investment Policy
  7. Invest Part of Your Portfolio In International Stocks To Reduce Volatility
  8. Rebalance Your Portfolio Periodically Or Upon Significant Change

Eight Potential Mistakes - Any One of Which Can Defeat Your Chances For Success

  1.  Failure To Diversify Among Individual Securities Paying Too Much In Hidden Transaction and Opportunity Costs
  2. Failure To Diversify Among Asset Classes
  3. Losing Too Much to Taxes
  4. Mistaking Past Investment Management Success For Skill
  5. Lack of Emotional Fortitude;
  6. Failure To Adhere to An Investment Discipline
  7. Paying Too Much In Disclosed Fees and Costs
  8. Not Planning For Inflation
As you may surmise, there is a lot to know to be an expert in investing. The depth of knowledge required to take advantage, successful  of each of the strategies set forth above is quite large. And the discipline and requisite knowledge to avoid the mistakes is also large.

Like it or not, understanding the capital markets, and the economic forces that affect them, is not an easy task. And investors' behavioral biases can get the best of them, from time to time. Hence, even if "commoditization" is taking place, there is a need for a guiding hand.

Which brings up another issue. What is the price to be paid for an expert guiding hand?

While an expert fiduciary investment adviser can add significant value to the investment portfolio of a client, and even enhance returns while reducing various risks, such experts deserve to be compensated - at a level of other professionals with expert knowledge and skill. Yet, if the compensation becomes too great, the value add can be substantially eroded.

Many investment advisory firms add additional value through providing financial planning advice. The breadth and depth of knowledge required for financial advice is tremendous. As a practical matter, most beginning financial planners (who on the path to becoming expert financial advisors) not only must undertake a great deal of study of a great many subjects, but also serve an apprenticeship of a type. Usually this involves several years working in a firm as a junior advisor. Indeed, while I often opined, when working in my prior firm, that I could educate a junior advisor in applying our investment strategy over the course of a year, I also opined that becoming an expert financial planner would likely take up to ten years, even with concerted effort and ongoing learning.

This brings me to the issue I pose to readers of this blog. But first, I assume that financial planning is separated out from portfolio management, in terms of separate engagements. Second, I assume that financial planning (excluding portfolio design and management) is undertaken as a necessary first step prior to investment management. In other words, each new client to an investment advisory firm must first receive personal financial planning advice, if not from that firm through a separate engagement, then from another firm.

Assuming such is undertaken, what is the possibility that a non-profit entity could be formed for the purpose of providing investment advice and portfolio management? Fees charged to the client would be a combination of:

  • low AUM percentage fees (for activities such as payment of costs relating to O&E insurance, etc.);
  • hourly fees for establishing accounts or other "variable time" activities (leading to the imposition of higher fees for account commencement and transfer activities, for example); and
  • flat fees for such activities as portfolio rebalancing, capital loss harvesting, investment policy statement formulation, and to pay general fixed overhead expenses.
Why am I even thinking of this? Well, I've been considering how to better educate my students. After receiving input from the Advisory Board for the Alfred State Financial Planning Program, we are making some changes to our curriculum to afford students more instruction in various software programs, counseling, and communications. To a large degree, these software systems (CRM, PMS, IPS generation, scanning software, file storage, form generation software, etc.) are already utilized in an investment advisory firm. Rather than employing versions of such software with hypothetical data, I believe the students would benefit greater from using such software (under supervision) with actual clients. Students would also receive exposure to working with a custodian, and learning (and then using) trading software.

So, would forming a non-profit entity be a solution? There are obvious benefits:

  • Students would receive not only real-world experience, but also compensation. Bonuses, in the form of payment for expenses to attend industry conferences, could also occur.
  • Student education would be enhanced.
  • Advances could be made for students to study for, and obtain, Series 65 licensure, which could then make them more attractive (together with the experience gained) to potential employers.
The costs of such an undertaking, and the effort required, are not to be underestimated. Although the non-profit would be a separate entity from my college, to use the non-profit for educational purposes would likely require greater complexity. For example, law firms to assist with formulation of documents to form the entity, CPA firms for oversight of the finances, legal/compliance firms for oversight on a periodic basis, etc.

Office space for such a firm would likely be leased from the college. Not to meet clients, but for students to have a place to go for training, collaboration, and getting the work done. Since our college is an hour from any metropolitan area (1 hour to Corning, 1 hour 15 minutes to Rochester, 1 hour 45 minutes to Buffalo), most of our students reside on campus. (Our campus' policies require this for students under age 23, who don't have parents living nearby; hence 80% or more of our students are residential students.) With a small campus, students are only a 5-10 minute walk away, at most, from wherever the office for the firm would be located.

Of course, there is a lot of work required, both initially and thereafter, to develop model portfolios, undertake ongoing investment research and due diligence (although with strategic portfolio management, and the use of passive funds from Dimensional Funds Advisors, the due diligence requirements are reduced). I would hope that, if the firm grew, an astute graduate could be hired to help supervise the firm and take over many of the due diligence activities.

Non-core functions would be outsourced, such as payroll, bookkeeping, compliance (to the extent it can be outsourced), computer databases (all data in the cloud), web site design and hosting, etc.

Financial planning would be outsourced as well. Why? It would take a great deal of effort and time to supervise students undertaking financial planning for clients. I doubt there is sufficient time in my schedule to tackle such an endeavor, and there is no other faculty member who would likely be involved in such a firm (we have a small, but growing, Financial Planning Program at Alfred State). In my view, the investment advisory firm would have to become much bigger, and have additional supervisory staff, before proceeding into such an area - if it ever did. Expanding into financial planning would require its own business plan, an established infrastructure, and experienced financial planners working in conjunction with students. I wouldn't rule it out, but I suspect such an endeavor would be several years away, at a minimum.

A concern would be competing with potential employers of our students. However, we could be an "internet-only" firm and decline to serve any potential clients from western New York State (Binghamton to Syracuse and all points west). Also, students would be required to sign confidentiality and trade secrets covenants. (Perhaps, however, they would be free to approach clients with whom they have a relationship to move with them to a firm in which they find permanent employment; this might make some of our students more attractive to local firms.)

Following formulation and adoption of a formal business plan, capital would need to be raised to foster the formation of such a firm. (Perhaps a loan to the non-profit from one or more prospective clients could provide the initial capital, including working capital. Or another benefactor found.) Fees might be higher at first, but then scaled back for all clients as economies of scale are achieved and any debt incurred is re-paid. In fact, I would foresee that clients of the firm would have, at a minimum, an advisory board to review and advise upon firm policies.

So what do you think? This is just a preliminary outline of such a non-profit firm. But, do you see any insurmountable barriers? Are there major considerations which are being overlooked? Is the notion of such a firm contrary to capitalism? (Although Vanguard might take exception to that.) Most importantly, is this a good way to attain the objectives - providing students with greater real-world experience and training?

Please feel free to comment on this blog. If you prefer to comment privately, please e-mail me at Thank you in advance for any feedback.

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