What Is Investment Management?
Investment management is a term that refers to the service of buying, selling, and monitoring financial assets or securities with the goal of achieving specific investment outcomes over time. The most common financial securities used in investment management are stocks, bonds, mutual funds, and exchange traded funds (ETFs). Investment management involves creating a written strategy for buying and selling portfolio holdings, monitoring accounts over time, and implementing a risk management approach to protect liquidity and access to income.
For the purpose of this article, we are going to discuss investment management services that are offered to individual investors by an investment advisor, financial advisor, or financial planner. An entirely different discussion can be had about how investment management firms offer services to corporations or institutions.
Investment managers or advisors who work directly with clients are expected to align an investment strategy with their client’s risk tolerance (comfort with risk), goals, and investment time horizon (how soon they might need to spend the money), to help them achieve an appropriate return over time.
The objective of investment management is to ensure that the portfolio remains aligned with the client’s long-term financial goals, adjusting strategies as necessary to respond to market conditions and changes in the client’s life. Investment managers and financial advisors also provide guidance regarding the benefits and consequences of contributions and withdrawals to help clients reach their goals and minimize their tax liability.
How Does Investment Management Work?
The process of client-facing investment management typically involves these key steps:
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Assessment of Client’s Financial Situation:
This step involves gathering comprehensive information about the client’s current financial situation, including their assets, liabilities, income, and expenses. This information helps an investment manager understand how much risk is appropriate or suitable for a client.
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Set Financial Goals:
Investment advisors who have financial planning expertise, such as CERTIFIED FINANCIAL PLANNER™ (CFP®) professionals, will work with their clients to identify and outline their goals. Common examples include saving for a child’s education, buying a new home, or retirement planning. The time horizon of a client’s goals guide the risk profile of the investment strategy.
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Developing an Investment Strategy:
An investment manager develops a strategy that takes into account the client’s risk tolerance (comfort with risk), time horizon (how soon they might need to spend the money), and financial goals. The investment manager or advisor uses this information to determine an appropriate asset allocation, which involves spreading investments across different types of assest to reduce any unnecessary risks while trying to maintain an appropriate return.
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Portfolio Management:
Portfolio management is the ongoing process of buying, selling, and maintaining an investment portfolio. The investment manager monitors the portfolio’s performance and asset allocation over time as market conditions evolve and makes adjustments as needed to keep it aligned with the client’s goals. The investment manager will also guide their clients on the benefits and consequences of contributions and withdrawals in an attempt to help them reach their goals and minimize their tax liability.
How Do Investment Managers Make Money?
Client-facing investment managers typically bill clients using the following fee structures:
Assets under Management Fees:
This is probably the most common way investment advisors bill clients for their services today. An assets under management (AUM) fee is a stated annual percentage of the total assets that a client invests with their advisor.
For example, if a client invests $750,000 and their investment manager charges a 1% assets under management (AUM) fee, then the client will pay $7,500 in a given year. This fee is usually paid quarterly by dividing the annual percentage into 4 and is directly withdrawn from the invested accounts to cover the investment management services.
Flat Fees & Annual Retainers:
Growing in popularity and sometimes offered by investment managers that include financial planning services, fees may be billed as a flat annual fee or annual retainer that covers both the cost of investment management and financial planning advice.
Annual flat fees or retainers can be $8,000+ and are often billed directly from the client’s bank account in monthly or quarterly installments. This type of billing arrangement works well for high income clients who are willing to pay directly for planning and investment advice.
Commissions & 12b-1 Fees:
An older and less common method of charging for investment services is when an investment professional sells individual securities to their clients and receives compensation in the form of commissions.
Investment professionals who are selling mutual funds may also receive a small amount of recurring revenue in the form of 12b-1 fees that the client pays inside of their investment holding. Often these investment professionals are not acting as fiduciaries, meaning they are not acting in a best interest capacity but in a sales or transactional relationship to a client.
What Are the Key Concepts in Investment Management?
Here are some key concepts in investment management to know:
Asset Allocation:
Arguably the most important variable that impacts long-term investment returns and client success is a client’s asset allocation. Asset allocation is to the mixture of different asset classes, such as stocks, bonds, cash, and alternatives inside a given investment strategy or account.
Each type of asset inside an investment strategy should have a specific role. Some assets are more risky and are included for long-term growth, while some assets are more conservative and are designed to lower risk and volatility. An effective asset allocation should balance risk and reward according to the client’s risk tolerance and investment goals.
Diversification:
Diversification is a risk management strategy that involves spreading investments across various sectors, industries, and asset classes. Diversification helps to minimize risk by ensuring that poor performance in one area does not significantly impact the overall portfolio. Sometimes diversification is a term used interchangeably with asset allocation but diversification goes deeper than just what asset classes are being used.
For example, an investment manager can build an asset allocation that is 60% stocks and 40% in bonds. To fill that asset allocation, the manager could choose 1 stock holding and 1 bond holding. This example of an asset allocation would not be diversified as the success or failure of an individual holding or company could make an outsized impact on the returns of the strategy.
Risk Management:
A great investment manager spends a considerable amount of time helping his or her clients identify and reduce any unnecessary risks in their investment strategy. Investment risks can be broadly categorized into 2 main areas: systematic risk and unsystematic risk.
Systematic risk cannot be reduced through diversification. Examples of systematic risk include market risk (the risk that the total market experiences a downturn), interest rate risk (the risk that interest rates increase or decrease in a way that negatively impacts performance), and purchasing power risk (the risk that your investments don’t allow you to keep up with inflation over time).
Unsystematic risk generally can be reduced with proper diversification. Examples of unsystematic risk include individual business risk (the risk of any individual company’s value decreasing), and liquidity risk (the risk that you aren’t able to liquidate your investment quickly for cash).
Active vs. Passive Management:
Active investment management involves regular buying and selling with the goal of outperforming a specific benchmark. An investment manager that attempts to predict the future performance of individual companies or market sectors is likely an active investment manager. Active management tends to involve a high level of research and monitoring and therefore tends to come with higher fees charged to the client.
A passive investment strategy starts with the belief that predicting the future is impossible. Instead of trying to predict the returns of individual companies or market sectors, a passive investment manager will likely purchase exchange traded funds (ETFs) or mutual funds that identically track major market indexes. Because these funds are simply holding the exact companies listed in their corresponding index, there is no regular buying and selling and therefore less need to charge high fees to the client.
What Are the Common Types of Investment Management?
Client-facing Investment management comes in a few common forms:
Traditional Investment Management:
Client-facing investment management has traditionally been provided by financial advisors. The investment manager builds portfolios for their clients using standard financial instruments like stocks, bonds, mutual funds, and exchanged traded funds (ETFs) with a focus on achieving appropriate returns for a client over time given their comfort with risk and investment goals.
Historically, the investment portfolios being managed were the main focus of the relationship and the financial advisor was not providing any other significant financial planning for their clients.
Wealth Management:
Many clients today are seeking a relationship where they can have their investments managed but are getting advice about all areas of their financial life. Wealth management is an industry term that implies a holistic service including financial planning, asset management (investment management), tax planning, and estate planning.
These services are often provided by financial institutions to high-net-worth clients or by financial planners who offer a combined financial planning and investment management relationship to their clients.
Hedge Funds & Private Equity:
Hedge funds are alternative investment vehicles for high-net-worth and institutional investors that use pooled funds to employ advanced strategies, such as leveraging and short-selling, to achieve active returns.
Hedge funds are known for their high risk-reward profiles and aim to provide returns that exceed stock market averages. Because of their risk profile, they often charge high fees and sometimes have liquidity restrictions.
Private Equity involves investing in private companies or buying out public companies to restructure and improve them. Private equity investments are typically illiquid and have a long-term focus, aiming for substantial returns through the growth and sale of businesses.
Benefits of Investment Management
Professional investment management offers several benefits:
Professional Expertise:
Investment managers and advisors have extensive knowledge and experience navigating investment strategies through various types of financial markets. Financial advisors and investment managers who carry designations including the CERTIFIED FINANCIAL PLANNER™ (CFP®) designation or the Chartered Financial Analyst® (CFA®) designation are well-equipped to help you navigate complex market conditions and make informed investment decisions.
Time Efficiency & Peace of Mind:
Delegating investment management to professionals saves you time and potentially mental stress. Your investment manager takes on the responsibility of researching appropriate strategies and investment holdings for you, saving you time and effort. It can also be a huge relief knowing that your financial advisor or investment manager is looking out for your best interest as they guide your investment strategy to help you achieve your goals.
Customized Investment Solutions:
Professional investment managers provide tailored investment solutions that align with your specific needs and goals. If you are in a high tax bracket, you might need an investment approach focused on tax efficiency, whereas if you are in a low tax bracket, you might benefit from a growth strategy regardless of the tax ramifications.
Contribution & Withdrawal Strategy:
Your financial advisor or financial planner can provide strategy guidance around how much to contribute over time to your investments as well as the tax benefits and consequences of contributions and withdrawals. Investment managers can be incredibly helpful in monitoring your investment withdrawal strategy to make sure your investment income doesn’t run out.
Why You Need Professional Investment Management
Working with an investment manager, financial advisor, or financial planner can provide you with objective guidance and align your investments with your goals. Emotion can cause you to make poor investment decisions. Having a financial advisor guide your investment strategy to match your goals can be a great way to help you avoid costly financial mistakes.
Contact Stage Ready Financial Planning Today for Professional Insight on Your Wealth Goals
At Stage Ready Financial Planning, we specialize in fee-only financial planning and investment management for individuals and couples over age 50 in Dayton & Southwest, Ohio. Our team of CERTIFIED FINANCIAL PLANNER™ professionals and experienced investment managers provides personalized advice so that you can feel confident about your retirement income and goals.
Whether you’re looking to retire successfully, invest with confidence, or reduce your taxes, we are here to support you. Schedule your intro call today!
FAQs
What is the main goal of investment management?
The primary goal of investment management is to achieve appropriate returns on investments relative to the client’s financial objectives and risk tolerance. Investment managers also assist with navigating safe withdrawal strategies and the tax benefits/consequences of making contributions or taking distributions.
Is investment management the same as investment banking?
No, investment management focuses on managing client investment portfolios, while investment banking deals with raising capital, underwriting, and facilitating mergers and acquisitions for corporations.