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Testing an Advisor with Part of Your Portfolio

A reader writes in, asking:

“What do you think about testing an advisor for a few years by giving him just a piece of the overall portfolio before turning everything over?”

I think the answer depends on what type of advisor you’re considering. But first, let’s get something important (and perhaps obvious) out of the way: Intentionally withholding information from your advisor is generally unhelpful if your goal is to get the best advice possible. As a result, anybody giving you financial advice should at least know about all of your holdings.

If we’re talking about a professional who only gives as-needed advice rather than actually managing the portfolio (e.g., an hourly financial planner), you’ll be the one in control of the portfolio the entire time. There’s no real downside to showing them everything – if you don’t like the advice you get you can always choose not to implement it.

If we’re talking about an investment manager, and the idea is to give them a portion of the portfolio to test their performance over a given period, I have to say that such an approach doesn’t make sense to me. Before giving the advisor so much as a dollar, you should have both a good understanding of their investment philosophy and a high degree of confidence in that investment philosophy. It needs to be the sort of relationship where you continue to value their services even during periods of poor performance, because there will be such periods. That is, you should choose an investment manager based on the fact that they practice an investment philosophy you believe in, not based on their performance over a particular short period.

On the other hand, I think there are some cases in which a small-scale test for an investment manager can make sense. For example, if we’re talking about an online-only investment manager (e.g., Betterment or Wealthfront), and your concern is something mundane for which you can get a clear yes/no answer right away (e.g., whether you will like their website, interface, etc)., then it can be perfectly reasonable to move a very small amount of money over to them to see what you think before transferring the whole portfolio.

If we’re talking about a commission-paid advisor, it usually makes sense to stay away completely rather than giving them even a piece of your portfolio. A commission-based pay structure creates significant conflicts of interest between the client and the advisor, which typically results in subpar advice, such as recommendations of undesirably expensive investments.

Investing Blog Roundup: Segmenting a Retirement Portfolio

Since I first encountered his blog several month ago, Dirk Cotton of The Retirement Cafe has been one of my favorite investing/retirement writers. This week, Cotton explains why segmenting a retirement portfolio for different purposes (e.g., one portion for general spending needs, another for potential long-term care needs) can be advantageous:

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Protecting Your Portfolio from Old Age

A reader writes in, asking:

“I recently read that the average person’s ability to make good financial decisions starts to decline as early as their 50s. Aside from hiring an advisor (too expensive) what can be done?”

There are several possible steps to consider, each with the goal of either simplifying your portfolio or reducing your reliance on your portfolio.

First, it can be helpful to reduce the number of investment accounts you have — and keep them all with one firm. Rolling all of your previous employer-sponsored accounts into IRAs, and combining all your IRAs at one place makes things much simpler. It’s easier to stay on top of everything if you can see it all at once on a single statement or website.

Second: Create a low-maintenance portfolio. If you’re worried about a decline in your ability to make good decisions, you don’t want to be bothering with individual stocks or actively managed mutual funds, trying to follow them closely enough to know just when to sell (a difficult task for even the sharpest of investors). A portfolio of passive, broadly-diversified mutual funds requires less work. And the fewer holdings you have, the easier it is to rebalance your portfolio as necessary. For many investors it will even make sense to simplify all the way down to a single all-in-one fund that requires no ongoing maintenance.

Third: Delay Social Security. While waiting to take Social Security often makes sense purely based on the numbers (especially for the higher earner in a married couple), it also has a benefit from a simplification standpoint in that it provides you with a safe source of income that doesn’t require you to make any ongoing decisions.

Fourth: Buy a single premium immediate lifetime annuity. Such an annuity is basically a pension from an insurance company. Buying such an annuity is typically a worse deal than delaying Social Security, but doing so can make sense if you want to further increase the amount of non-portfolio income you receive each month (i.e., income that, like Social Security, does not require any ongoing decisions).

And finally, I do think that hiring somebody to manage your portfolio is one of the better ways to protect yourself against declining financial acumen. At the risk of sounding like a broken record (having discussed this just last week), there are now several firms that offer portfolio management for a fairly low cost — either a small percentage of the portfolio (less than half of one percent per year) or a flat fee.

Of course, none of the above strategies are one-size-fits-all. Some might make sense for you while others do not.

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Investing Blog Roundup: Vanguard Financial Plan

As we briefly discussed on Monday, one of the least expensive ways to get a basic financial plan is through Vanguard. Harry Sit of The Finance Buff recently decided to go through the process himself, and he’s reporting on the experience for anybody interested in following along.

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How Much Should You Pay a Financial Advisor?

This tax season, relative to preparing my return by hand, I would say that TurboTax saved me at least $500 worth of time and stress. And I imagine it will save me a comparable amount of time and stress next year. So, come January 2015, if Amazon is selling TurboTax for $400, would it make sense for me to buy it?

Of course not. And the reason is obvious: I can buy it elsewhere at a much lower price.

When promoting their services, many financial advisors like to state that their fee is a bargain because they can improve most investors’ portfolio performance by an amount equal to or greater than their fee. For example, an advisor charging 1% per year might argue that the fee is worth paying because, without an advisor, most investors will lose at least 1% of performance per year due to picking poor funds, misguided attempts at market timing, and other mistakes that the advisor will help them to avoid.

The problem with this analysis is that it fails to ask whether the same services can be purchased elsewhere at a lower price.

Paying for Portfolio Management

The price of portfolio management (i.e., the actual running of the portfolio — purchasing funds, rebalancing, etc.) is quickly being driven downward due to competition.

At the most basic end, a Vanguard Target Retirement or LifeStrategy fund is a version of portfolio management — maintaining a diversified selection of index funds for a cost of roughly 0.10% per year (relative to the cost of a DIY index fund portfolio).

But, for various reasons, funds of funds are a poor fit for some investors (e.g., people with lots of assets in taxable accounts or people who want an allocation not available via a fund of funds). Fortunately, the selection of low-cost portfolio management providers is growing. For example:

In addition, as recently reported on the Bogleheads Blog, for a cost of 0.30% per year, Vanguard’s new Personal Advisor Services gives you portfolio management, plus a basic annual financial plan from a CFP, plus a designated CFP to contact when you have questions.

Paying for Advice

As far as paying for actual advice, if your needs are basic, you can again get what you need for a very modest cost. For example, Vanguard offers a basic financial plan for $250 for anybody with $50,000 or more invested with Vanguard and completely free of charge for anybody with $500,000 or more invested with them. Vanguard describes the service as providing “answers to important questions, such as:

  • When can I afford to retire?
  • Will I have enough saved by retirement?
  • How much can I spend in retirement?
  • Which investments are best for me?”

Alternatively, there are numerous independent financial planners who can skillfully provide such services for a modest one-time fee. (The Garrett Planning Network would be a good place to look, for instance.)

In short, basic portfolio management and basic portfolio-related advice are both available at a very low cost these days. Paying anything more only makes sense when you need (and are going to receive) more specialized or more thorough services (e.g., a retirement plan that incorporates not only investment decisions, but also Social Security decisions, tax planning decisions, and health insurance decisions).

Investing Blog Roundup: Risking Your Safe Retirement Income?

There are a number of different strategies for providing retirement income. You can purchase an insurance policy to guarantee you the necessary amount of lifetime income. You can use a ladder of bonds (and/or CDs) to provide safe income for a certain number of years. You can use a periodic withdrawal strategy from a mixed portfolio of stocks and bonds. Or you can use some combination of the above.

This week, Dirk Cotton, author of the blog The Retirement Cafe, explains why many people may find betting their safe retirement income in the hope of achieving a higher standard of living later in retirement to be an undesirable tradeoff:

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