After spending nearly two decades in the wealth management industry, working with clients at some of the largest banks and registered investment advisor (RIA) firms, I saw the same pattern. And if you’re a professional who has ever worked with a financial advisor, I bet you’ve heard this story.
It goes something like this: “The best strategy for your retirement planning is to invest in a diversified basket of index ETFs, hold them for the long term, and you’ll be fine.” It’s simple, it sounds safe, and it’s the standard playbook for most of the RIA industry.
But there’s something most advisors won’t tell you. This isn’t how the truly wealthy actually build and protect their fortunes. And that’s the huge disconnect between the advice given to the public by financial planners and financial advisors versus how the Ultra-High-Net-Worth and family offices invest their money.
The standard approach of a “buy and hold” with a portfolio of funds rebalanced once a year—consistently delivers average results. In good years, you might match the market. In bad years, you’ll match the underperformance (or worse after fees).
The Index ETF Illusion
The financial industry has been pitching index ETFs as the best solution. The pitch is: low fees, instant diversification, and returns that match the market. But when you buy an index ETF, you’re essentially signing up for average, forever. On top of the internal fund fee paid to the ETF, you’re paying an investment advisor a fee of 1% to be an asset allocator—a job that could be done by simple online tools.
What’s really interesting is what the academic research shows about diversification. A comprehensive study from the Paul Woolley Centre found that concentrated portfolios of just 25-30 stocks consistently outperformed both widely diversified mutual funds and their benchmarks. Essentially, you capture the vast majority of diversification benefits with a just a small number of holdings. And research from Nomura showed that you achieve about 90% of the maximum risk reduction with around 40 stocks. Beyond that, the benefit becomes negligible.
When you over-diversify by buying multiple index ETFs, you’re not getting a better-protected portfolio. You’re often just getting diluted returns and hidden overlap, with many funds holding the same large-cap stocks.
Warren Buffett: “Protection Against Ignorance”
Warren Buffett and Charlie Munger have been saying this for years. They argue that focusing on a handful of high-conviction positions actually reduces risk because it forces you to deeply understand what you own.
Buffett’s famous line says it all: “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” In his 1993 letter to shareholders, he elaborated, explaining that a policy of portfolio concentration can decrease risk if it raises the intensity with which an investor thinks about a business.
And this is exactly how sophisticated investors operate. Research from family offices across the globe shows a clear pattern:
- They Own Stocks Directly: Most of their allocation to equities are in individual stocks, not ETFs.
- They Are Active, Not Passive: They actively manage their public equity portfolios.
- They Are Tax Optimized: By owning individual stocks, they can strategically sell losers to offset gains—a level of tax management that isn’t possible with a mutual fund or ETF.
This is the entire premise behind sophisticated custom portfolio management. It’s about control.
You can also look at how tech’s most successful founders and executives invest their own money. They don’t just plow it all into the S&P 500 index. They make concentrated bets on companies they understand, maintain significant positions in individual stocks, and use their knowledge to spot opportunities before they become mainstream.
The Overlooked Power of Tax Efficiency
Another major advantage of owning individual stocks is the control it gives you over taxes. With an ETF or mutual fund, you have none.
I saw this firsthand year after year at a large RIA firm where I used to work where our clients’ portfolios were built mostly from mutual funds. And every December, it was like clockwork—we’d have to explain why they were receiving big tax bills from capital gains distributions passed on by the funds.
These were caused by capital gains distributions from the funds—something we, as their advisors, couldn’t prevent. It didn’t matter if the client’s account was up or down; they inherited the fund’s tax liability.
I would sit with clients, looking at a statement showing their fund had lost money, and then explain why they owed thousands in taxes on it. The fund manager might have sold appreciated stocks within the fund earlier in the year to rebalance or meet redemptions from other investors. Those gains have to be distributed to the current shareholders—that’s you—even if the fund’s overall value dropped by year-end.
But with direct ownership, your financial planning can be much more strategic:
- Tax-Loss Harvesting: You can sell specific losing stocks to create a loss that cancels out a taxable gain. For example, harvesting $10,000 in losses could directly save thousands of dollars in taxes for that year and this alone can add 1-2% annually to your after-tax returns.
- Control Over Timing: You decide when to take gains, aligning it with your broader tax picture, like years with lower income or after exercising stock options.
- Wealth Transfer: For your estate, individual stocks receive a “step-up in basis” at death, which can eliminate capital gains taxes entirely for your heirs.
This level of tax strategy is used by the sophisticated investors when it comes to wealth management.
Building Your Strategy
So, how does this look in practice? Based on academic research and real-world application, an optimal concentrated portfolio often contains 20-30 individual stocks. This provides the lion’s share of diversification benefits while still being concentrated enough to generate meaningful outperformance.
Success here is built on a few key principles: focusing on quality companies, leveraging your own expertise, maintaining discipline through volatility, and applying active risk management by managing position sizes and sector exposures.
So why isn’t this the standard approach you hear from every advisor? Because the business of mass-market wealth management isn’t built for it. It’s much easier to manage hundreds of clients by using ETF-based templates than it is to do the meticulous work of building and managing individual stock portfolios.
On the other side is hands-on active portfolio management. To access this, you need a partner whose entire philosophy is different. You want a registered investment advisor who is a fiduciary not just in name, but in practice—someone who specializes in the craft of building portfolios with individual securities.
You want a partner, such as a Certified Financial Planner (CFP), whose expertise is in tax-efficient investing and building a portfolio that is meticulously tailored to your own finances. That’s the key to leaving the standard playbook behind.
Ready to move beyond the standard advisor playbook?
At Paraiba Wealth, our focus is on building actively managed portfolios—a strategy designed for greater control, tax efficiency, and tailored to you. If you’re ready to see what this looks like, book a no-obligation initial call today.