With the advent of low cost index funds, the case for an expensive investment advisor grew considerably weaker. As technological advances have given way to robo-advisors (e.g., Betterment and WealthFront), the case in favor of expensive advisors has all but cratered. It was with this background that I read the following email from a reader named Rob:
Q:I just signed up to get your newsletter and I’m looking forward to getting advice from you. I’m a physician in New Jersey and I’ve been using a financial advisor who has been investing my money, both pension and non-pension, in mutual funds over the past 8 years. His fee is one percent per year and the mutual funds all have expense ratios between one and two percent. I just opened up a Vanguard account and I’m considering transferring all of my money into Vanguard funds, specifically, one of the target date retirement funds. My thought is, I would save the one percent fee per year and the fund expenses are much lower. What are your thoughts? Also, do you have any recommendations on specific mutual funds, Vanguard or other, that I can put my money into for the long-term that would be better than a target date retirement fund?
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A:Rob’s question is an important one. A one percent advisory fee will have a significant impact on a portfolio over a lifetime of investing. Even just a 0.50% fee can make a huge difference. As a result, if you have the time and are comfortable investing your own money, it’s absolutely the right way to go. There’s no reason to pay an advisor one percent of your money each and every year for the rest of your life if you’re comfortable doing it yourself.
And that comes from someone who just passed the Series 65 exam and is moving towards becoming an investment advisor to help people manage their money, for a fee. If a potential client were to come to me and say, “Rob, I think I’m comfortable investing my money on my own, but should I hire you instead?” My answer would be, “Absolutely not. Hiring me is the last thing you should do.” Why in the world would you hire anyone to manage your investments if you’re comfortable doing it yourself?
Now there are a few things to consider. Many will argue that you need an advisor so that you want abandon your investment plan when the market nosedives. While this is an important consideration, don’t be too quick to assume you’ll stick with a plan just because you have an advisor. In the world of investment advisors, it’s common knowledge that many, many clients were lost in 2008 and 2009. Clients pulled out of the market and fired their investment advisors.
In fact, I’d argue that sticking with an investment plan has more to do with other factors, not whether you have an advisor. Investors in passively managed index funds are more likely to stick to a plan than those with actively managed funds. Those with all of their finances in order (e.g., little consumer debt, reasonable mortgage, retirement savings on track) are also more likely to stick to a plan.
Yet not everyone is comfortable investing on their own. Others may not want to spend the time to become a DIY investor. Such individuals may be better off hiring an advisor. But that doesn’t mean they need to pay one percent. Vanguard now offers investment advisory services for 30 basis points.
Rob’s email highlights another alarming occurrence that I see frequently. Not not only is he paying his advisor one percent, but his advisor is also placing him into mutual funds that are costing him an additional one to two percent. These are likely actively managed mutual funds. This underscores the importance of looking at all of your investment costs, not just the advisor fee. You have to look at the cost of the underlying funds as well.
In addition to a total cost of two to three percent, Rob also needs to consider the transaction costs. A mutual fund’s transaction costs are not included in its expense ratio. For actively managed funds, these transaction costs can be very significant.
In terms of specific recommendations, what I told Rob was that I couldn’t make recommendations for him. It’s interesting, because as I move towards a business where I will be able to do that, of course for a fee, whether you have me manage your investments or not, I started to think about how I would handle that. There is a lot more that goes into creating an asset allocation plan then picking the investments to execute on that plan. A number of factors must be considered, including the investor’s tolerance for risk, a lot of tax considerations in terms of where you should hold different investments and, obviously, your goals and time horizon.
Rob mentioned Vanguard’s target retirement funds. We talked about those in the past. I think most big mutual fund companies offer them and that’s certainly a great way to go. It’s very easy. You can simply invest in a single fund and you’re done. It’s that simple. Compared to paying two to three percent between advisor fees and high expense mutual funds, in my view, you’d be much better off with a one fund solution.
Finally, one thing I did mention to Rob in terms of specific recommendations is this–call Vanguard, Fidelity, T. Rowe Price, or the mutual fund company of your choice. They will talk to you over the phone and help you work through these issues. I did that with my father-in-law and Vanguard. They were very patient and worked through the options with him and we were able to come to a good selection of mutual funds. So, one of my recommendations to Rob was, if you think you want to look at something beyond target-date retirement funds and you’re interested in Vanguard, give Vanguard a call.Topics: Investing