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What Portfolio Personalization (Really) Means

Updated: Jan 29

Starting With A Classic


One of my all-time favorite movie quotes (which has since been recycled into many memes) is attributed to Inigo Montoya, in the classic "The Princess Bride" (if you haven't seen it, this should become your main priority after reading this article). It is triggered when Vizzini repeats his catchphrase - "inconceivable!"

Inigo then turns to him and says:

"You keep using that word. I do not think it means what you think it means."

I can't help thinking about this quote every time I see how financial institutions (FIs) promise "personalized" portfolios to their customers. In my previous article, I demonstrated why portfolio personalization is so important. However, I did not elaborate on what portfolio personalization actually means, and for a good reason - it's a somewhat elusive concept.



Before Diving In


1. In this article, I will try to keep the financial jargon to a minimum. Occasionally, I will use financial terminology, for which I will provide linked explanations.

2. FIs refer to banks, investment institutions, RIAs, robo-advisors, and any other type of service provider who advises or manages retail investor savings.


What FIs Mean By Personalization


In July 2016, Betterment CEO, Jon Stein, wrote an article titled "Meet Your Personalized Investment Manager." The word "personalized" appears 10 times throughout the article (including the title).


The type of personalization that Stein was referring to is framed within a financial, risk tolerance view. This means that Betterment (and just about every other FI today) generally sorts its customers into a few (typically between 5 to 10) different portfolio asset allocations, based on a "risk score".


This score is generated based on a series of finance-related questions, such as:

  • What is your investment purpose/goal?

  • What is your investment horizon?

  • If the market were to lose 20% of its value overnight, how would you react?

  • What is your annual income level?

Then, based on each FI's methodology (which tend to be rather similar), the customer's risk score is calculated and the allocation is set.


For a simplified example, let's look at two individuals: Bob, a 75 year-old retiree, and Mike, a 31 year-old who has just finished paying off his student debt and is on a promising career path. Bob might receive a low-risk score of 1, resulting in an allocation of 90% fixed income(low risk, low expected return), and 10% equity (higher risk, higher expected return). Mike, however, might receive a high-risk score of 5, resulting in an allocation of 10% fixed income, and 90% equity.


As far as most FIs are concerned, both Bob and Mike have just received "personalized" portfolios, based on their financial parameters. But how personalized can their portfolios really be when, as I mentioned above, they "fall into" one of 5 to 10 portfolio allocations?


For a modern-day analogy, imagine if Netflix suggested that you spend 70% of your time watching movies, and 30% watching TV series. Perhaps, if you insisted, it might even suggest that within the movie category, you should spend 60% of your time watching action films, 30% watching comedies, and 10% watching horror films.


Would this experience feel personalized and tailored to your exact taste and needs? I have a feeling that if Netflix offered this kind of service, it wouldn't be the colossal ~$130B company that it is (as of April 2018).


So why is it that Netflix truly personalizes your viewing experience, recommending spot-on specific movies and TV series to you based on your unique taste, while FIs get away with a cookie-cutter model? Don't get me wrong, there are some great investment products out there, financially speaking.


However, matching customers with a financially well-balanced portfolio that suits their risk level is only one part of the personalization equation.


What Personalization Should Mean


True personalization must take each individual's unique "world view" into consideration in a holistic manner. It is important to understand what I mean by "world view", since this term will be used going forward. An individual's world view is comprised of all aspects of their life (not necessarily finance-related) that make them who they are. This includes their background, demographics, fields and levels of education, occupation, fields of interest, values, and the list goes on.


Ultimately, as this world view becomes clearer, the personalization becomes more accurate and effective.


To demonstrate, let's revisit our example. Remember Mike? What I didn't mention (and his FI didn't even ask him) is that Mike is a neurosurgeon who strongly believes in clean energy. He doesn't smoke (in fact, he can't stand tobacco-related products), and he loves playing basketball on weekends.


Mike's friend from college, Maya, is also 31 years-old. She studied Software Engineering and firmly believes that Big Data and AI are the "next big things". Maya loves animals and enjoys flying her recreational drone on weekends.


Clearly, Mike and Maya have a very different world view. They come from different backgrounds, work in different industries, are familiar with and believe in different things, and have different hobbies. They may both be 31 years-old, plan to invest their savings in order to retire (in about 30-35 years) and have a similar level of income, but does this mean they should be investing in identical portfolios? Of course not.


Mike might like his portfolio to include medical devices and sportswear companies, along with Tesla, his favorite clean energy company. He would most certainly not wish to invest in any tobacco-related companies.


Maya, however, may want her portfolio to include cutting-edge tech companies that are applying the latest data-driven AI algorithms. She might also like to invest in drone companies, and she would definitely not wish to invest in companies that test their products on animals.


Starting to sound a bit more like a financial Netflix, right?


But Is This A GOOD Investment?


This is usually the point where you're probably thinking "But who says it's a good financial investment? Just because someone is familiar with, likes or believes in certain fields, does that mean they should invest in them? This is money we're talking about!" The short answer to this is a resounding YES - people should invest this way.


When managed properly and responsibly, there is no conflict between investing in a compelling and familiar (i.e., personalized) portfolio, and having a well-balanced, financially appropriate one. As the saying goes - "there is more than one way to skin a cat!"


I will dive deeper into the theory and mechanism of how this works in a separate article.


Summary


When addressing the issue of portfolio personalization, one must definitely consider the financial requirements and constraints of the investor, as FIs do today. But there is another side to that coin, which is almost entirely ignored by FIs - the investor's world view.


Only when these two complementary elements are combined, can real and meaningful personalization take place. Only when Mike and Maya receive different portfolios (naturally with similar levels of risk and expected return) that reflect who they are as individuals, will their FIs be able to wholeheartedly claim that they have offered them a personalized portfolio.


This means that instead of 5 to 10 cookie-cutter portfolios, there will be countless individual portfolios to accommodate each investor's needs and world view.


This will increase their likelihood to invest their savings (why?) while understanding and relating to their investment. Their overall satisfaction from the investing process will be much higher, and they will have secured their financial future.


Ultimately, isn't this the experience we deserve as investors? And isn't this what our FIs should want for us as their customers?


#WealthTech #Fintech #Personalfinance #personalization #personalizedportfolios #roboadvisors #Investment #AI #machinelearning #innovation #Cred #MakingInvestmentPersonal


I am CPO and Co-Founder of Cred. Cred is a disruptive WealthTech startup aimed at enabling financial advisors and institutions to truly personalize each of their retail clients' portfolios, based on their unique backgrounds, financial situations and preferences. This is the way investing will work in our generation, and we’re excited to be pioneers on this journey.

Feel free to contact me at ilan@credinvest.co, and find us on Facebook and LinkedIn!


Disclaimer:

When you invest in securities, you always hold the risk of losing some or all of your money. I am not a licensed investment advisor, and the above content was written as an informative article to the general public. It should not be viewed as financial advice by me or by Cred to any specific group or individual under any circumstances. Any investment action you decide to take is solely at your discretion and at your own risk.





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