Fees, Fees and More Fees

There’s an obvious phenomenon in the world of personal finance and that is an obsession with fees.

As an entity with decades of experience advising human beings with $1000 to invest up to $100 million liquid net worth, the attention paid to fees is warranted and overdone.

We humans are apt to commit to a philosophy when it comes to investing like we do when it comes to political, religious or social affiliation.  It is the animal in us that wants to belong to the group.

Unfortunately, politically, socially and financially, group-think can be harmful to our health.  Take mutual fund investors, particularly index advocates, without mentioning a group of devotees to Vanguard’s John Bogle by name.

Indexers, the ones I’ve encountered both in person and in the comments section of articles I’ve written elsewhere, are often absolutists; regardless of the evidence indexing is the only way to go and you are an idiot if you pay higher fees for any other type of fund.

Now, let me be clear, I use index funds and have done so for many years.  They serve a great purpose and can be the building blocks to the core of a portfolio.  But there are many, many other fund choices in the world with higher fees and also superior performance.

The stat toted around by many in the biz is that “80% of funds do not beat their benchmark in any given year.”

OK, so what?  It would take even a novice about three minutes to go to Morningstar.com and find mutual funds that have beaten the S&P 500 over any period we wish.

In a mutual fund universe with, I don’t know, lets say conservatively 10,000 funds (I know there’s more), 2,000 of them are beating their index.  Net of fees.

This goes for other investment products as well.  The issue isn’t fees on their own.  The statistic fund investors should be focused on is total return net of fees, because that is the number reflects how much money you’ve put in your wallet.

And I’ve really had conversations with people who, despite superior net returns, opted for an inferior performing index fund rather than the superior performing actively managed fund.

To each her own.  Me, I look for net returns.  I know there are a ton of great funds that beat their benchmark.  But I also index.  That part of my portfolio is at the core.  It remains largely unchanged.  And my active investing is done with what I call “satellite holding”.. That is where I earn my alpha.  And every investor should do this.  A core of the basic building blocks of a portfolio (large, mid small cap, international, fixed income, et al.) and seek out sized returns with a revolving cast of characters depending on circumstances.

There are a lot of people who don’t have the time, talent or temperament to do anything other than buy and hold with index funds, and that’s fine, really.  But if this is you, realize that buy and hold with a blind adherence to the belief that index funds are the solution can lead to disaster.  This is not an indictment of index funds, but an acknowledgement that blindly buying and holding, without periodic reviews and the counsel of a professional other than the Bogleheads Message Board (they’re not pros anyway) can lead to problems.

Remember the shorter your time horizon the less likely any fund can counted on to perform the way it did in the past.  10+ years return data is only applicable to investors who have 10+ years to buy and hold over.

Pre and post-retirees with short time horizons or the complicating factor of periodic withdrawals for income supplementation have a whole host of other concerns.  And are most likely to need professional help.

A twenty or thirty-something with many decades to go, fine, set up a periodic investment program into a diversified portfolio index funds or ETFs or mutual funds, work hard, and take a peek once a year.  But the closer you get to retirement, th more vigilant you must become.

The bottom line is this: successful investors are not committed to a group mentality, not committed to a type of product, nor devotees of a an investment guru (except the author of course) nor are they closed to hearing about different options, even ones that John Bogle says you should avoid.  Mr. B. did great things in his career and deserves all the credit he gets for his innovations.  But the world of investing moves forward.  There are new products and services introduced every year.  And even a deep a cynic as I am understands that yes, some of these products are designed to fatten the bottom line of the organization that is manufacturing it, but not all.  Keep an open mind.  Learn about different strategies, products and services.  You’ll be glad you did.




The New DOL Fiduciary Standard: Harmful or Helpful?

Well, the jury is still out since the rule is not in effect and the real impact will be properly assessed retrospectively, but there are real concerns, especially for those of you with not a lot of money.

And of course the people most likely to be directly affected are the ones who may be least aware of the change and how it may impact the products and services they have access too.

According to expert feedback the DOL rule will curtail some variable annuity sales (a lot by some estimation) and compel financial firms and advisors to redirect investor dollars that would have previously been recommended a variable annuity to managed money accounts, a la Registered Investment Advisers (RIA).

The reason?  Well, the new rule imposes a fiduciary standard to not only employer sponsored retirement plans (like 401ks) but also to non-employer sponsored retirement accounts, like Traditional and Roth IRAs.

In this regard, the DOL motivation is clear, variable annuities (VA) can have significant expenses, which the DOL interprets as excessive and that those advisors who sell them are not acting in the clients best interest.

At times, this is true, there are advisors who sell VAs to anyone and everyone simply for the compensation.  Some annuities do pay hefty commissions, and here again the DOL presumably thinks the commissions are in excess (and for certain there are annuities that pay huge commissions, but these are mostly issued by companies MainSstreet America never heard of before their salesman came a-calling).

So for lower asset level investors for whom a VA may have been used in the past, the DOL rule will presumably force advisors (who won’t risk violating the rule or at least want to avoid violating the current interpretation) will have to shift those client assets that would have landed in a VA to something else.  Most of the industry discussion in this regard is that those assets will move to managed money accounts, RIAs and the like.

So, most people will ask, what’s wrong with that?  I’ll tell you.

Most of the time, advisors who recommend VAs do so not for the commissions but because the VA is the best option.

You see, people with less money need greater guarantees, specifically when it comes to retirement.  Wealthy individuals aren’t worried about running out of money, “Mass Affluent” in America (people with $100k to $1mm in investable assets) do.  And those with less than $100k especially so.

If you’re worth a couple million and have a reasonable standard of living you have more choices as to where to invest your retirement assets for sustainable lifetime income.

But for people of lesser means the DoL rule may in fact cut off a valuable option for having a secure retirement.

VA’s offer guarantees that can not be had anywhere else.  An investor can buy a VA and rest assured that the income it produces will never end and may even increase depending on the product.

But RIAs, mutual fund portfolios, ETF portfolios, separately Managed Accounts (SMA), none of these provide guarantees.  And many of them are exclusive, meaning you need a minimum amount of money to open an account, commonly $500k, $1mm or more, although there are options for lower asset levels.

And if you investigate these lower-minimum programs, some as low as a $50k minimum, what you think you’re getting is not what you actually get. These mutual fund wrap programs simply bundle a bunch of mutual funds together, based upon 5 or 6 allocation types (Conservative to Aggressive) and charge an annual fee (a percentage of the assets invested) for “managing” the portfolio.

That’s terrific, until you realize that you have exactly the same portfolio as a million other people and your ultimate success or failure is really simply dependent on the market, not the management ability of the company running the portfolio.

Now here’s where the DoL misses the point with regard to fees: lower fees do not make a product or service better.

Lower fees makes one product in a category of comparable products better in that similar products (like S&P 500 Index Funds) with comparable strategies and allocations experience better performance due to the lower fees in comparison to the same type of product.

But comparing an index fund to a VA is stupid.  They serve different purposes.  People buy VAs for the guarantees and which for many investors and professional justifies the higher fees.  VAs offer guarantees with regard to Death Benefit, Growth, Lifetime Income etc.

Wrap programs, ETFs and Mutual Funds provide no guarantees.  So the lower level investor who really needs the guarantees will be rejected and forced into a non-guaranteed wrap account or worse, robo-advisor.

“Protecting” the little guy in this case may actually do a lot of harm.  People with lower asset levels need guarantees because the risk of running out of money is real, and managed money accounts cannot guarantee that.

And with many retirees expecting to live 20, 30 years and beyond, guarantees become more valuable than ever.  Forcing advisors to consider fees first, rather than what is truly in the clients best interest, may prove harmful to the Individual Investor.

And this impact is not just limited to VAs.  The DoL rule may have impact elsewhere.

But for the individual investor it is important to understand that advisors that are concerned about the new rule and the scrutiny every transaction will receive (not whether it’s right for the customer but whether it complies with the DoL’s mandate) will defer to a lower cost product or service, even if the argument can be made in favor of the most “costly”option, or they may reject the prospect entirely.

For firms and advisors, the benefit of the commissions received are greatly outweighed by the oversight and risk of intervention by the government, and the lawsuits that may follow.

So the rejected prospect or client will be forced to go to wherever he or she is welcome.   This means that the people who would most benefit from some higher fee products or services with guarantees will have less options to choose from, including those that might be completely appropriate, simply because the DoL is “protecting” them.

VAs with guarantees will be cast aside for a lower cost wrap account, which thanks to the DoL shifts the risk from the company (by guaranteeing against loss of income or asset in a VA) to the customer in a non-guaranteed wrap account.  A customer who often doesn’t know how to manage money or assess the performance a portfolio relative to sustainable and inflation adjusted lifetime income.  A customer who will be forced to rely on “Robo-Advisors” and online tools, and for many, a customer won’t realize something is wrong until it’s too late.



Defining “Retirement”

What does retirement mean to you?

The truth is, it means a lot of different things to people.  At times I’ve been surprised by the reaction that word gets from one person to the next.

Even couples, perhaps unsurprisingly, have drastically different views about retirement.

I’ve had people get visibly angry at the suggestion that they would ever stop working, as though that would an admission of diminished usefulness…

While I’ve had others who couldn’t wait to retire so they could sit around and do nothing at all.

So one of my first suggestions to people with regard to retirement is to try and visualize, and be able to communicate to their advisor, as close to reality what their ideal retirement will look like.

Now, when I say “ideal”, it means within your grasp, not the lottery type answer I sometimes get (I’d buy the island of Maui if I could).

Because that information, what your ideal is, is critical to an advisor providing you with the best advice possible.  Of course, plans do change.  People who retire with a very tight budget do occasionally win the lottery.  Others that expect to live and be active until age 100 do occasionally get ill despite a family history of above average longevity.

Your advisor should be discussing with you what I call the “most likely scenario”.  Your most likely scenario should include things like a realistic expectation for longevity.  For some people this can be challenging.  In my case, my father passed away at the young age of 56 while my mother is alive and well at 81.  My plan includes a contingency for the unpleasant possibility that I die younger rather than older.  Of course I am also planning to live to 90 or beyond, but only time will tell.

And what about all that money you’ll be spending in retirement?  Some traditional recommendations are to assume you’ll need 85% of your working income in retirement.  Well, maybe, but maybe not…

I’ve known plenty of retirees who ended up spending more money in retirement than they did while they worked, simply because they were healthy and active and had 50 – 60 hours each week no longer occupied by commuting and working.

But I also have known people who spent far less in retirement, living at a very minimal financial level quite happily.  I had a client who retired at 40 years of age.  He was unmarried, had no kids, and could live quite happily on $10,000 per year.  That’s not me for sure, but it can be done.

So you really need to know yourself.  Your advisor’s advice is often only as good as the quality of the information you provide. Advisor’s can “guesstimate” when their clients withhold information, but you may be disappointed with the results.

It you withhold information in a misguided attempt to “protect” yourself it would be like going to the doctor and asking for a recommendation after simply saying you don’t feel good.  Can the doctor accurately provide advice to resolve your malady with so little information?

And if your advisor is the type of person that makes you feel like you need to withhold information I suggest you start looking for a new one…

And not unlike a doctor, financial advisor’s sometimes have to deliver bad news.  You know the old saying, “Don’t kill the messenger”? Well, I’ve gotten looks that made me think my life was in danger when a client didn’t get the answer he wanted…

If your advisor tells you you don’t have enough financial resources to retire, don’t get mad, get a second opinion.  Remember that the advisor is probably being honest and trying to help.  What you don’t need is a “Yes Man” who will tell you everything is great even if it is not.

If you are honest with your advisor, and yourself, about your wants and the reality of your situation you will have the best chance of retiring successfully and creating a lifestyle that will meet or exceed your ideal.