The wealth management practices of the Wall Street firms and big banks are broken. Again.
To understand this point, it's important to step back and remember that regardless of which particular investment was the flavor of the month, the common theme heard over and over again in the big investment houses over the past 30 years was that by dividing your assets among many different categories that won't move in the same direction at the same time, you were going to reduce the overall risk.
This premise seemed to have some validity and was appealing to the average investor–until October 2008, when virtually every category except high quality short and intermediate fixed income investments got caught in the same downdraft. Put another way, the Wall Street wealth management model failed its biggest test. Investors who were told that they were diversified suffered losses of double or triple the magnitude of what they were told to expect during a tough year.
What went wrong? The fixed income substitutes pushed by the major investment houses–"low volatility" hedge funds, preferred stocks, asset backed securities or other structured products, closed-end bond funds, income/mortgage REITs, and master limited partnerships–weren't fixed income substitutes at all. None of them is a substitute for the most important characteristic that investors should be looking for from the fixed income portion of their portfolio: safety of principal.
This takes us back to why the Wall Street firms' wealth management models are obsolete. First, investors may finally wake up to the fact that these firms have incentives to sell complexity and that most bad advice can be traced to bad incentives. For example, hedge fund managers were incentivized to take risk through their "two and twenty" structures. There are no clawbacks of the outrageous incentive fees paid to those fund managers who levered their portfolios 25 to 1, had a couple of great years when things were good, and then proceeded to blow up in 2008.
For too long, Wall Street has, in the name of "innovation" and winning the competitive race, dreamed up products with marketing sizzle versus looking for far simpler products to meet customer needs. Or put another way, they have strayed from the mission of helping investors meet their goals. It's far less sexy to tell someone to invest a third of her assets in bonds and buy a basket of high quality companies (or an index fund) with the other two-thirds and then have the discipline to rebalance, thereby taking fear and greed out of the equation. Not only is it less sexy, it's less profitable.
