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Financial Advisor Fees Are Irrelevant, If You’ve Already Paid Them

A reader writes in, asking:

“After reading your books and others on the Boglehead reading list, I think I’ve determined that my new money should go to Vanguard index funds. But I’m thinking about keeping my existing savings with the advisor I’ve been using for several years. I’m less optimistic than ever about his ability to beat index funds but it seems like leaving him would mean that all the money I’ve paid in commission and fees over the years would be a waste. Does this line of thinking make sense?”

To put it bluntly, no, that line of thinking doesn’t make sense.

In economics, the commissions and fees that you’ve already paid your advisor would be referred to as “sunk costs” (i.e., costs that you’ve already paid and which cannot be recovered regardless of which action you take). For decision making purposes, sunk costs are irrelevant and should be ignored.

This concept is often best explained with an analogy. Imagine that it’s Saturday afternoon, and you just spent $9 to see this summer’s latest blockbuster movie. Twenty minutes into the movie, however, you realize that it’s simply not for you. In fact, it’s terrible. At this point, the $9 ticket price is irrelevant. Sitting through the rest of the movie doesn’t get you your $9 back. All that matters is what you want to do with the next 90 minutes of your life. If sitting through the rest of the movie isn’t the option that brings you the most happiness, you shouldn’t do it.

Commissions and fees that you’ve already paid to an advisor are like that $9 movie ticket. You’re not getting them back. So the only question that matters is which route looks best going forward.

In other words, if there is no cost to make the switch (e.g., capital gains taxes), the only thing that matters is which you expect to perform better in the future: money that you have invested with the advisor, or the Vanguard index fund portfolio that you’ve planned. If you think the index funds would perform better, there’s no sense continuing to pay more fees just because you’ve already paid some fees.

Investing Blog Roundup: Spending in Retirement

This week, two articles dealing with recent retirement-related research came across my radar — one discussing income, spending, and overall satisfaction in retirement, the other discussing mental health in retirement:

Investing Articles

Thanks for reading!

Investing Blog Roundup: Market Valuations and Retirement Asset Allocation

Housekeeping note: We have family and friends visiting from out of town this week and early next week, so there will be no article on Monday.

This week researchers Wade Pfau and Michael Kitces released a new paper looking at an assortment of different asset allocation strategies in retirement — ranging from various static allocations, to various “glide path” allocations that either increase or decrease the stock portion over time, to various valuation-based allocations that adjust the stock/bond ratio over time based on whether stock valuations are high or low.

The paper and the authors’ respective summary articles can be found here:

If I were to offer my own very brief summary, it would be as follows:

  • Based on historical US data, adjusting asset allocation based on market valuations has modestly improved results for retirement portfolios, and
  • A fixed 60%-stock allocation is pretty darned good as well.

Investing Articles

Thanks for reading!

A Look at Vanguard’s Managed Payout Fund

A reader recently wrote in asking for a discussion of the Vanguard Managed Payout Fund — how it works and what it might be good for.

In short, the fund is meant to be a tool for investors who are spending from their portfolios (i.e., retirees). It’s an all-in-one fund (like the LifeStrategy or Target Retirement funds), but it also implements a withdrawal strategy for you. In other words, the fund handles not only asset allocation and rebalancing, but also the implementation of a distribution strategy. Pretty neat idea, in my opinion.

What is the Distribution Strategy?

Perhaps the best way to assess the Managed Payout Fund’s distribution strategy is to compare it to other strategies.

The best known retirement distribution strategy is the classic “4% rule,” in which the retiree spends 4% of the portfolio balance in the first year of retirement, then automatically adjusts spending upward each year in keeping with inflation, regardless of how the portfolio performs. The advantage of this strategy is a steady level of spending (in inflation-adjusted terms), with the disadvantage being that someday the portfolio (and, therefore, the spending) could hit zero if things go poorly.

An alternative, equally simple strategy is to take 4% out of the portfolio each and every year. Relative to the classic “4rule,” this results in widely varying levels of spending (which is undesirable), but it has the advantage of never fully depleting the portfolio.

The strategy of the Vanguard Managed Payout Fund sits between these two — with a level of spending that does vary based on portfolio performance, but that is “smoothed” by basing the withdrawal on the average share price over multiple years. (Specifically, the fund sets a monthly distribution in January of each year, based on 4% of the fund’s average share price over the last three years.)

Vanguard Managed Payout Asset Allocation

As of this writing, the Managed Payout Fund’s allocation is as follows:

  • Vanguard Total Stock Market Index Fund 25.0%,
  • Vanguard Global Minimum Volatility Fund 20.1%,
  • Vanguard Total International Stock Index Fund 14.9%,
  • Vanguard Total Bond Market II Index Fund Investor Shares 13.3%,
  • Vanguard Market Neutral Fund Investor Shares 10.0%,
  • Vanguard Total International Bond Index Fund 6.9%,
  • Vanguard Emerging Markets Stock Index Fund Investor Shares 5.1%, and
  • Commodities 4.7%.

Frankly, I’m not exactly a fan of this allocation. I’m not talking here about the stock/bond allocation (though with a net** stock allocation of roughly 65%, it is rather aggressive for many retirees) or the US/international allocation. I’m talking about the fact that roughly one third of the portfolio is actively managed. If I were to bet on active management, it would be Vanguard’s that I’d want to bet on, given their low costs and strong track record. But I’d rather have the option to use this sort of all-in-one tool without having to make such a bet.

Conclusion

In short, Vanguard’s Managed Payout Fund might be a good fit for investors who:

  • Are retired and drawing from their portfolios,
  • Appreciate the simplicity of an all-in-one fund and an automated distribution strategy,
  • Don’t have any qualms about active management, and
  • Find that the fund’s allocation is a good fit for their risk tolerance.

In addition, like all funds-of-funds, this fund will be less tax-efficient than a DIY portfolio with individual index funds, making it somewhat less desirable for investors with significant assets in taxable accounts.

** I say “net” stock allocation because the Market Neutral Fund shouldn’t, in theory, be contributing any stock market volatility.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Investing Blog Roundup: Fixed Indexed Annuities

As I’ve written on several occasions, I’m a big fan of annuities as a tool for providing retirement income. But that doesn’t really extend beyond boring lifetime annuities. Fixed indexed annuities (a.k.a. equity indexed annuities) are an entirely different animal. And as Allan Roth explains this week, there are a number of potential “gotchas” involved with such products.

Investing Articles

Other Money-Related Articles

Thanks for reading!

How Big Does Your Portfolio Have to Be Before It Should Look Different?

A reader writes in, asking:

“For the last several years I’ve been following a basic Boglehead strategy with a few index funds. How big does a portfolio have to be before it makes sense to start moving into other strategies?”

There are certain portfolio-related considerations that can become relevant as your wealth grows to a certain point. For example:

  • If your portfolio starts to get to the point that estate taxes might be an issue (with the exemption currently at $5.34 million – or twice that if married) and your primary goal is leaving money to heirs rather than funding your retirement, purchasing life insurance as an investment can make sense, or
  • If you have a larger, mostly taxable, 7-figure portfolio and a desire to be hands-on, individual stocks can make sense for the large-cap part of the portfolio — not with the idea of picking stocks that will outperform, but rather with the idea of creating a portfolio that roughly replicates the overall large-cap part of the market, while having expenses of zero (no expense ratios and no commissions) and having the ability to tax-loss harvest very aggressively due to having many unique holdings.

But, the truth is, most investors’ portfolios never reach those points — or even come close.

In addition, the basic principles of diversifying and keeping costs low remain applicable regardless of portfolio size.

As a result, for most people, it’s not exactly portfolio size that causes a need for a significant change to the portfolio. Instead, it’s usually a change in life/career stage that dictates major changes. That is, once the primary objective for the portfolio changes from an accumulation goal (i.e., accumulating assets while not exceeding your tolerance for volatility) to a spending related goal (e.g., satisfying $X of spending each year), the ideal tools for the job change somewhat.

Specifically, as you near retirement, it can make a lot of sense to start shifting toward a liability-matching strategy with a portion of the portfolio — creating a “safe floor of income” with things like Social Securityannuities, or TIPS. As author/advisor Bill Bernstein puts it, “If you’ve won the game, why keep playing it?”

Of course, portfolio size is a factor in determining when you make the shift from living off of work income to living off of the portfolio, but it’s only one of several factors (including ability to continue work, interest in continuing work, anticipated level of spending per year, and anticipated level of non-portfolio income per year).

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."
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