Occasionally I have had to cope with a client's unexplainable affection for a stock. In my very first portfolio makeover assignment, I unwittingly recommended selling 200 shares of Hershey. The lady, whose modest girth offered no hint that she was among the most ardent consumers of that company's fine products, sat down to our presentation exclaiming emotionally, "You can't sell my Hershey." It turned out to be the only objection she had to my recommendations, but she made it clear that it was a non-negotiable objection.) To this day, one of the questions on my interview checklist is, "Do you have a personal attachment to any of these investments?"

These and other real-life complications, both quantitative and emotional, need to be addressed and evaluated by any advisor who wants not only to create a retirement portfolio that reflects all his or her best investment judgments, but also a portfolio that the client can embrace.

Entering Bert's World

Bert Johnson's portfolio offers a useful model for suggesting ways that the advisor charged with redesigning a new client's portfolio could address some of these personal investment realities.

The Johnson's portfolio, if I may charitably refer to it that way, was classically messy. Among my associates we call a thoughtlessly accumulated list of securities a "Shoe Box" portfolio, and a really out-of-control collection we refer to as a "Weed Garden." This one was deep into Weed Garden territory! The Johnsons had one or both of their names on five tax-deferred retirement accounts, two variable annuities, two taxable brokerage accounts, a Treasury Direct account, four separate mutual fund accounts and 12 stock certificates held in a safe deposit box, four of which had developed corresponding dividend reinvestment plans.

When I begin to analyze a portfolio with the intention of overhauling it, the first issue that I like to address is the account structure and titling. I have learned over the years that clients are very appreciative of our ideas for simplifying their investment world by consolidating accounts and reducing the number of institutions with which they have to maintain a relationship. Before I prepare their Investment Plan, I ask whether any of their current accounts represent personal relationships that they would rather not disrupt. In Bert's case, his two variable annuities had been purchased from a brother-in-law who was no longer in the insurance business, so we did not have to work around any relationship issues.

The annuities were traditional high-expense versions still dragging a 6% surrender charge that would reduce by 1% a year. I explained that we could preserve the tax-deferred character of this investment by arranging a 1035 exchange into a low-cost VA with no surrender charges. Although the switch would involve a $2,400 hit to a $40,000 market value, I continued, the 2% per year expense savings would recoup it in 3 years. I usually explain this situation by saying that from the insurance carrier's point of view it is a matter of "pay me now or pay me later." When you bought the contract you incurred the cost, whether you eventually pay it in a surrender charge or in high annual expenses. When, as is often the case, a 1035 exchange also can improve the available range of investment choices, clients usually agree with our judgment.

As a personal financial advisor I am not especially enthusiastic about Treasury Direct accounts, even though I understand and appreciate that they can reduce an investor's transaction costs, which usually involves a relatively small amount of money. For one thing, it is one more institutional relationship to deal with; both my clients and I value structural simplicity above a small cost saving. For another, owning Treasury bonds outside of a brokerage account complicates the process of reallocating resources within a portfolio. Hilda Johnson had, indeed, opened the Treasury Direct account to save money on bond purchases, but she had not bothered to learn the routine for bidding on new bonds, and it was easy for her to agree to close this account.

DRIP accounts present a similar circumstance-small cost savings on transactions but a constraint on portfolio changes and an unnecessary extra set of reports to deal with. Regarding the Johnsons' individual stock certificates, which Hilda had inherited from her mother, I encouraged her to deposit them into a traditional brokerage account for better record keeping and to make eventual selling and asset rebalancing easier. We also discovered that half of the stocks were actually a gift from her mother during her lifetime and half were received much later as an inheritance. So that we could understand the cost basis and make informed judgments about the tax consequences of any sales we might recommend, we questioned Hilda about the dates of the gift and her mother's date of death. We could then research the price history of each stock.

As I mentioned above, Bert had told me that his retirement portfolio was worth $500,000. In fact, the current market value the day I first met with him was closer to $450,000. Because the stock market has been in general decline for three years, I find it rather common that prospective clients believe their portfolios are worth more than they actually are. I don't know if they are in denial or just don't add them up very often. But I have had situations where a few months into our relationship a client begins to think that a portfolio shrinkage took place on my watch when in fact the damage had occurred before we met. It turns out they imagined a certain out-of-date value when they first came to see me. So, one of the first things we do when a new client engages us is request current statements for every account and enter the current values of every security into our Investment Plan spreadsheet, noting the valuation dates on our worksheet. This doesn't solve the problem of a market decline in already-owned investments before we have an opportunity to change them, but it does help clarify where our responsibility began.

Pilot Or Co-pilot?

Sometimes new clients will make it clear that they are hiring you to exercise your best judgment and have no need for involvement in the decision process. More often it is not so clear exactly to what extent your new client wants to delegate authority for the re-orientation of their investments. It is very important to discern at the beginning of the project whether your new client expects to hire a pilot or a co-pilot. (We are not talking about whether or not you have discretionary authority in managing a portfolio, for that should be made contractually clear. We are discussing the relationship expectations during the process of drafting a detailed Investment Plan.)