Home
Yesterday a financial institution offered to help manage my portfolio for a fee of only .75% per year. With that fee structure, they get ten times as much in fees from a client who has ten times as much in his portfolio, even if managing it is the same amount of work, which it presumably would be.

I assume at least part of the money these professionals propose to manage would get directed toward funds that are managed by yet other professionals who take even more of your money no matter how well they perform. And they too will get higher fees when you invest more, despite their workload being the same for any amount.

Part of the pitch for this financial service was that I would get to approve any adjustments to the portfolio they recommend.

Pause to digest that.

If I were smart enough to override the advice of experts, why would I pay the experts for advice? The entire system depends on me being dumb enough to think that concept makes sense. And what exactly was the opposite of that arrangement? Do other companies propose to invest your money against your will?

So suppose you give your financial advisor only half of your portfolio to manage, and then you duplicate whatever he does with the other half. Your results would be the same, but his fee would be halved. He'll argue that he needs to see the whole portfolio to do his job right, but he doesn't. You just need to be sure you have adequate liquidity (ready cash) in case you need it.

Someday someone will create a web service that has a few dozen sample portfolios that can fit just about any need. The user will answer a series of questions about his situation, and the system will spit out a portfolio suggestion. After that, the system will generate e-mails asking you to update your personal situation, in case that changes the portfolio recommendation, and alert you if any of your investments need to be tweaked.

The sample portfolios could be as simple as broad index ETFs, some domestic and some international, for the equities, and some bond funds for fixed income. All you would ever need to adjust is the percentage of your funds in each type of vehicle once every several years.

If the tiny fees of the ETFs are still too rich for your blood, it wouldn't be hard for someone in the know to come up with a sample portfolio of say 25 individual stocks that are likely to perform just like an index. You pay the discount broker fee once, and adjust every few years as needed.

Now you will tell me it is already being done.
 
Rank Up Rank Down Votes:  +13
  • Print
  • Share
  • Share:

Comments

Sort By:
Jul 15, 2009
I wonder if altruistguy even knows what a 'comment' is...
Bit like one of the cubicle sociopaths here at the bank I work at, no such thing as a quick note all his e-mails fill the screen
12 paragraphs of text every meeting request etc....geez
 
 
Jul 13, 2009
"Despite some of the cynical "lawyers-are-to-blame" comments here, your potential adviser is actually interested in what you think when giving you the option to override his/her chosen strategy."

Sorry, PHB, the legal implications for an expert not involving a non-expert customer in the decision process was not a cynical comment, it was a statement of fact. The fact that the expert advisor may actually find the customer's response to the advice to be interesting or useful is secondary and unrelated to the underlying legal implications.

Webster
 
 
Jul 13, 2009
I agree with Scott and disagree with altruistguy completely. Here's just one point.

If I gave a financial advisor $100,000 to manage, tell him it's all the money I have for investing, and share my risk tolerance and time horizon, he will (should) put together a diversified portfolio. Small caps, large caps, bonds, fixed income, etc. He'll make $750 off me this year for his services (plus my portfolio will take a hit from transaction costs or points).

But say I really have another $100,000, or $200,000, or $500,000 more than the $100,000 I entrusted to the advisor. I could apply the same asset allocation ratios to my personally-managed funds, and get the same results for far less than $750.00 a year in trading fees. My entire portfolio would be allocated at the same ratios as the advisor set up.

I also want to see the advisor who takes a percentage of the GROWTH of the client's portfolio. That is a confident professional.
 
 
+2 Rank Up Rank Down
Jul 13, 2009
You are making assumptions that people actually care enough to learn how to invest on their own and that they can remain competent enough to actually execute a well conceived plan. The fact of the matter is that people are scared p o o p-less and eagerly hire a "professional" to make these decision for them. You are making classic engineering-logic errors in believing people actually make rational decisions!

Despite some of the cynical "lawyers-are-to-blame" comments here, your potential adviser is actually interested in what you think when giving you the option to override his/her chosen strategy.

The independent fee-based Registered Investment Adviser business model is actually the most client-centric model that exists today that gives REAL, objective advice in building an investment plan. Boiling it down to a handful of questions and poof instant model portfolio is flawed thinking - much in the same way physicians diagnose health problems, all investing is personal. The crime is when one is forced into a model that does not take into account personal preferences and attitudes.
 
 
-1 Rank Up Rank Down
Jul 12, 2009
For the past 25 years the best-performing investment newsletter has been NoLoad FundX. It's similar to your idea. The newsletter looks at the best-performing mutual funds each month, then has you move your money into those. By shifting money around regularly, you take advantage of who's hot and who's not.

Plus it's dirt cheap.

http://www.fundx.com/customerhome.aspx

I used to have a Merrill Lynch adviser. Now I use FundX. Cheaper, easier, and better results. Love it.
 
 
Jul 12, 2009
You have hit on the paradox of investing. After 20 years of individual investing as a hobby I have arrived on this paradox. It takes a certain amount of perspective and time to learn and to understand that the financial services industry actually does more harm than good to it's customers. Lets just use mutual funds, for example, they actually create frictional costs and as a whole greatly under perform the index ( or average). We've all seen the studies of 90% of mutual fund managers don't beat the index. If all the managed funds were mandated tomorrow to move to low fee index funds, as a whole, investors would be better off.

Now, I could just tell you to buy low fee index funds or ETF's, but it would be extremely arrogant of me to expect you to follow my advice. If I could put my knowledge on a chip and insert it into your brain and have you go 'aha' that would be different. And heck, maybe I'm wrong and you would would say 'phooey'. But, my point is, it takes a lot of effort and learning and perspective to figure out that you don't need the service. Therein lies the paradox, because you don't want to exert that effort, you want to pay for it! Because it doesn't interest you or you don't have time or your building a house, whatever.

Now for any mutual fund manager out there, I will offer this. I do not think my knowledge or skill of investing is superior to yours. In fact, I would liken it to me playing Michael Jordan in a game of pickup one on one. My odds aren't very good. But if Michael has to play by the 'analogy' rules of the mutual fund industry, he would have to play on his knees with one hand tied behind his back. I like my chances. When you understand this you no longer would pay for the service.
 
 
Jul 12, 2009
Hello Scott,

I find it difficult to believe that you might have been serious when writing this entry -- I thought that you were far more well-informed on financial issues.

1) "... a fee of only .75% per year. With that fee structure, they get ten times as much in fees from a client who has ten times as much in his portfolio, even if managing it is the same amount of work, which it presumably would be."

First, 0.75% per year is a VERY good deal for competent management of a portfolio of -- perhaps a million dollars or less.

Second, there are several good reasons for a fee structure that is somewhat related to the amount under management -- the linearly increasing potential liability that a manager takes on. Twice as much under management suggests twice as much potential liability. Another reason is that larger portfolios really do take more effort to prudently manage than do smaller portfolios. If you had a billion dollar portfolio, do you really believe that prudently managing it would take the same amount of effort as prudently managing a $10,000 portfolio? No -- clearly not. I could elaborate on that point, but it would be too long a discussion.

2. "And they too will get higher fees when you invest more, despite their workload being the same for any amount."

I strongly suspect that the fees you are talking about diminish as the amount under management goes up. So, for example, perhaps that 0.75% only applied to the first million under management. The second million might only cost 0.4%, the third million only 0.25%, and so forth. This sort of setup reflects the facts discussed in item 1 above -- the fact that the amount of liability taken on by the advisor increases linearly with assets -- and the fact that the amount of work involved increases, but less than linearly.

3. "Part of the pitch for this financial service was that I would get to approve any adjustments to the portfolio they recommend. "

This is actually a smart thing for MANY reasons. Basically, we human beings are spectacularly good at "shooting ourselves in the foot" in financial matters. There are MANY well-documented psychological effects that we are subject to which tend to cause us to do things that are not in our fiscal best-interest.

What people tend to do is when they have negative surprises, they tend to panic -- and to do the worst possible thing at the worst possible time as a result of that panic. They sell low and buy high (or stuff money in a mattress).

By giving you rationale for prospective actions and asking your permission, the advisor is attempting to make you better informed about what is happening, why it is happening, and what sorts of things you can expect as a result thereof. The better informed investor is then less likely to be negatively surprised by what follows -- and is less likely to panic and to do the bad things that panic-y investors tend to do.

So this really is a good thing -- from a very pragmatic perspective.

4. "If I were smart enough to override the advice of experts, why would I pay the experts for advice? The entire system depends on me being dumb enough to think that concept makes sense. And what exactly was the opposite of that arrangement? Do other companies propose to invest your money against your will?"

The issue here isn't asking you to override the advice of experts, it is trying to help you get emotional buy-in -- to prevent you from panicking when things go south -- and hurting yourself.

Other companies don't propose to invest your money against your will -- they just don't ask. This is called "discretionary management". It is certainly easier for the advisor to do this. However, when things go bad, the investor, who doesn't understand what was being done for what reasons and what they should expect going forward as a result of those decisions, is likely to panic and shoot themselves in the foot.

5) "So suppose you give your financial advisor only half of your portfolio to manage, and then you duplicate whatever he does with the other half. Your results would be the same, but his fee would be halved. He'll argue that he needs to see the whole portfolio to do his job right, but he doesn't."

This shows great naivete. If you don't make your entire portfolio available, the entire portfolio can't be optimized.

a) Asset-location can't be optimized. For example, there is good research which indicates that it can make a big difference where you put different types of assets. For example, is it better to have muni bonds in a taxable account and stocks in an IRA, or is it better to have stocks in a taxable account and non-muni bonds in an IRA? It turns out that, unless your stocks are actively managed and have lots of turnover, the latter has been demonstrated to be better -- to the tune of as much as two percentage points better after-tax performance per year for the portfolio as a whole!

b) The portfolio may be dramatically less diversified than you'd like. Lets say that in the portion of the portfolio that you allow the advisor to manage there are lots of small-cap stocks. If the advisor isn't aware of that, he may add to the portfolio's small cap stocks to such an extent as to cause your overall portfolio to have MUCH too much of a small-cap bias. He can't do a good job giving your overall portfolio good results if you don't let them.

c) Due to the existence of price-breaks, as discussed above (i.e., where the more money you have under management, the lower the marginal fee to manage them), splitting a portfolio between several advisors would result in your paying each of them too much.

d) Some folks like the idea of splitting their money across several advisors in the interest of having a more diversified portfolio. HOWEVER, the more advisors you split your money across, the more your resulting overall portfolio is likely to resemble the "market" portfolio. For example, if you take this to the extreme and split your money across a million different advisors, then your resulting overall portfolio would certainly be "the market". But if you wanted a market portfolio, you could have gotten it far more efficiently and less costly just by buying a market index fund.

6. "Someday someone will create a web service that has a few dozen sample portfolios that can fit just about any need."

As another respondent has already pointed out, FolioFN has offered this for a long time. However, I see no reason to use that when you could use (much better diversified) index funds and/or ETFs instead.

7. It just doesn't make sense to hire somebody to help you, but to not let them help you.

It is like hiring a doctor to only look after the health of your left arm. You may be concerned that they will drive up the price of care if you allowed them to minister to the rest of your body. But the fact is that you care about (or SHOULD care about) the health of your entire body. And if you only allow a physician access to your left arm, that physician will not be able to be as effective in helping your overall body stay healthy as they would if you allowed the physician to treat your whole body.

8. Ultimately, your post reflected a (quite justifiable) deep suspicion of the financial services industry. It is a sad thing that most folks are so unable to look after their own investments buy that most folks they might engage to try to help them would tend to make them even worse off. That said, it is NOT true that competent, ethical advisors don't exist. Sadly, they are just in the minority and are difficult to identify in advance. The only way that I can think of to minimize the chance of being taken advantage of by the financial services industry is simply to avoid any such providers who "sell" anything involving commissions -- those people are actually salespeople just masquerading as objective advisors.

Eric E. Haas
 
 
+1 Rank Up Rank Down
Jul 11, 2009
"Part of the pitch for this financial service was that I would get to approve any adjustments to the portfolio they recommend."

While presented as an advantage for the customer, this is simply a device to shelter themselves against lawsuits down the road. This element of "the pitch" was proposed by a lawyer, not a marketing type.

"So suppose you give your financial advisor only half of your portfolio to manage, and then you duplicate whatever he does with the other half."

You could do that, and I suspect that many people do that. But the fact remains that it is an unethical thing to do.

Webster
 
 
Jul 10, 2009
I like that you come up with an entertaining anecdote, and imagine your perfect scenario then drop a challenge to find it every time you want to ask for advice. It's a great example of psychology and free-market economics at work. We have something you need (not me specifically, I have no idea), you pay us for it with entertaining prose. But you do it in a way that makes the contributor feel like he's meeting your challenge, rather than just doing your googling for you.

I wonder how long you've been doing this. I imagine people started telling you "that already exists" first, then you co-opted the sytem to your own advantage. I also wonder if you have a sophisticated Bayesian filter system that cross-references posts with a database that has ratings for all the advice given by a particular pooster so that it can pull out the most popular and credible answers.

This is why I love reading your blog, you give me ideas...even if they're not the ones you intended, and I can't express them all that well.
 
 
0 Rank Up Rank Down
Jul 10, 2009
your fee is partly to cover transaction costs, and they are proportional to the amount invested. the logical structure would be to charge a fixed amount plus a (smaller) percentage of the total invested. i guess they choose the precentage structure to favour tiny investors because they want customers to sign up, even with a tiny amount to being with. also i think small money is "stickier" than big money so it is more valuable.
 
 
+1 Rank Up Rank Down
Jul 9, 2009
You do know the true story about the monkey and the dartboard, do you?

Paying an expert to pick your stocks for you is like paying somebody to pick the right lottery-numbers. Wait, maybe there's money in that as well.
 
 
Jul 9, 2009

1) The last thing anybody who knows how to make money on the stock market wants to do is manage somebody else's money. The power of compounding is so powerful that he will soon have too much of his own money to manage.

2) Portfolio management fees may only be 0.75% a year, but what about other costs like brokerage etc. Every time the fund manager switches in and out of a stock, the same institution will charge you brokerage, sometimes as much as 2% a trade. By churning your portfolio aggressively, the total earnings of the financial institution will be much more than 0.75%, regardless of how much you earn.

3) The reason they want you to approve any adjustments to the portfolio is probably because they want you to take part of the moral responsibility if they end up destroying your money. Maybe this way it ensures you cannot sue them later.

As you very well said, "The entire system depends on me being dumb enough."

 
 
+2 Rank Up Rank Down
Jul 9, 2009
1 - I doubt it is a fixed percentage. I'm sure it is tiered. Try opening a $3,000 account and expecting to pay 0.75% ($22.50).
2 - At 0.75% per year, I assume there is more to the fee than just investment management. Advice on retirement, taxes, risk, estate planning, etc. is usually involved. For the most part, the more money someone has, the more complicated the situation becomes.
3 - Risk to the financial institution. The bigger the account, the more risk for a lawsuit and the bigger the possible judgment.
4 - There are many financial planners that will just charge a fixed annual fee.
5 - Hourly fees don't work because everyone underestimates how long something should take. That is true in every industry. People don't realize how long it takes to prepare a tax return, fix a car, build a house, etc.

I know Scott is always trying to "figure things out," but when it comes to investing, he's probably best off just sticking with appropriate index funds or ETFs and letting it be. If he has no faith in the financial industry, why is he wasting his time getting a proposal?
 
 
-4 Rank Up Rank Down
Jul 9, 2009
Algonad, I wish I had a product to sell to you. You seem ok with paying more because you have more money.

Your comparison only works if the cartoonist or musician manages to charge each purchaser on a sliding scale based on the size of their bank account. I do not pay 10 times the price for my newspaper because I have a lot of money in my wallet, and last I checked an iTune still only cost me about a dollar, perhaps you are paying $10?

Even if you go with the fact that bigger portfolios are harder to manage, I doubt the X2 cost factor for a $100K portfolio versus a $200K portfolio is really warranted. Look for size based and capped fees.
 
 
Jul 9, 2009
Some big-shot investment fund managers charge "1 and 1" - that is, 1% of the total portfolio, plus 1% of the return. Then they hand all the money over to Madoff. It works for about 10-15 years.
 
 
Jul 9, 2009
www.folioinvesting.com seems to be along the lines of what you're looking for: "We revise and rebalance Ready-to-Go Folios periodically and we send you email alerts each time. You can act on these updates or not."
 
 
Jul 9, 2009
Thanks for your post. It will hopefully provide enough incentive for me to get out of my relationship with Morgan,smith,citi,barney inc. that has been skimming too much from my paltry savings for 15 years. Psychologically, it is fascinating to observe my own anxiety about leaving my investment company (the devil you know), despite the fact that upheavals in the financial industry have changed my company's name 5 times in the last 8 years! As long as I keep getting statements in the mail, it almost feels like the same company. If only my company's default plan was a low cost (such as vanguard or fidelity), I would probably have saved thousands by now. That's why auto-withdrawal for savings is such a beautiful thing. It is hard to change it, so you spend less on other things.
 
 
Jul 9, 2009
My father-in-law owns a small financial planning company (he is the only employee). From discussing his business with him, I think you are not entirely correct in your assumption that larger portfolios require the same time and effort to manage that smaller portfolios do. For example, when selling significantly large amounts (relative to the total size of the index/fund/stock/whatever), you can't just go in and do it all at once, if you want to get the most out of it. If you try that, the price will start dropping as you sell more and more, and before you know it you've sold at a much lower average price than you intended. Instead, you have to make a series of smaller sales over a larger period of time -- thus there is more time and effort involved.

Interestingly, I think my father-in-law's standard setup is a much better deal than the one you described being offered by this mystery "financial institution". In particular, he doesn't take his fee when his investments perform poorly -- if your investments with him don't beat the money market rate (at least I think that's the marker), he doesn't take his fee again until your investments have recovered back past where they would be if they had been invested in the money market that whole time. Plus, although I'm not positive about this, I think his fee is lower than .75% to begin with. Sounds to me like the offer you're getting is a pretty lame deal in comparison, even if I'm not 100% correct with the details. I'd give my email address and offer to put you in touch with him, but then I think I'd be in violation of the terms of use for my account on this site ("your activities ... will not: ... advertise or promote a product, service, ..."). Since my email address is attached to this account, I'll assume that if you're interested enough you can find a way to send me an email.
 
 
Jul 9, 2009
Scott,

I religiously follow your one page advice on financial investing. Investing in an index portfolio (through an ETF or index fund) consistently over a period of time gets rid of all risk except market risk which is always there.

 
 
Jul 9, 2009
Umm, ShareBuilder anyone?
 
 
 
Get the new Dilbert app!
Old Dilbert Blog