In order to minimize risk and investment losses, it is important to properly balance a client’s asset allocation. Otherwise, your financial advisor can be liable for overconcentrating your account, or “putting all your eggs in one basket” so to speak. Asset allocation and overconcentration issues make a client’s account inherently unsuitable for them because of the risks that these issues present. This sort of “investment plan” may fail the quantitative suitability analysis imposed by FINRA Rule 2111. An advisor can be responsible for overconcentrating their client’s assets in one type of industry, security, class, or asset. This can mean anything from investing too much money in one stock, or investing too much money in stocks generally, compared to an account’s asset allocation in mutual funds, and bonds. If an account is overconcentrated in one investment or sector, then the client can suffer massive losses if there are issues with that company or sector. This was seen on a large scale with in the “Dotcom Bubble” or “Tech Wreck” in the early 2000s when U.S. technology companies saw massive, rapid increases in their valuations in the late 1990s, then crashed. Once the investment capital dried up, many of these companies quickly became worthless. Thus, investors who were overconcentrated in the technology sector suffered massive losses.
An advisor should also perform regular reviews of a client’s account to make sure that the performance of their account is not causing overconcentration issues. For example, using the tech wreck example, investor losses could have been prevented if an advisor reallocated their account after the account realized such large gain in the technology sector. Additionally, continuing to monitor an account asset allocation is necessary because a suitable asset allocation for a client may change over the course of their relationship with a firm based on a number of circumstances, such as changes in their risk tolerance, age and investment time horizon, or liquidity needs. A suitable asset allocation for a 40 year old client will change as he ages, retires, or as his net worth composition changes.
Analyzing the proper asset allocation for a client is not limited to reviewing just the assets held at that specific firm. A broker needs to review the client’s entire asset profile, such as real estate holdings, investment accounts at other brokerage firms, and annuity and insurance policies. This information should be reviewed at the outset of opening an account, and throughout the client’s relationship with the firm. For example, a large percentage of a client’s assets may be locked into their home or other real estate investments. If this is the case, then, generally speaking, additional illiquid investments, or more real estate-related investments will likely be unsuitable for the client.
A broker may also intentionally overconcentrate a client’s account to benefit themselves or their firm. In other instances, brokerage firms and brokers may intentionally overconcentrate a client’s account because certain securities provide more financial benefit to them. In recent years, it has been popular for firms to recommend a slew of alternative and illiquid investments like REITs, limited partnerships, tenancies-in-common, and other private placements because these investments pay a premium commission to advisors. Illiquid investments often pay brokers and their firms 10% or more in commissions, compared to investments like mutual funds, which are often 2% or less.
If you hired a broker, brokerage firm, or any other type of financial advisor, it is their responsibility to manage your account in your best interest, in line with your investor profile, and in accordance with securities industry laws, rules, and regulations. If are concerned that your broker has overconcentrated your account, or that the asset allocation of your account is not suitable for you, and you have suffered losses, call Stoltmann Law Offices for a free evaluation. We handle cases on a contingency fee basis, so we don’t get paid until you do.