Q: I use your investment ideas to manage my 401(k) account. My financial situation recently changed. Is there a wealth threshold at which you recommend hiring a financial adviser rather than going it alone? I found a few financial advisers through the National Association of Personal Financial Advisors (NAPFA) to meet with. How do I evaluate the value added? Is a financial adviser likely to better my investment returns with his fee included?
A: There are two kinds of services that most people need. One is investment management. The other is financial planning. All too often, both are mixed together. This tends to inflate the cost of managing your money. If you can, you should work with your fee-only NAPFA adviser on a fee basis for financial planning, telling him that you want to focus on low-cost index funds for your retirement portfolio.
Here’s why: Let’s say your adviser offers financial planning and portfolio management for 1.5 percent a year of a $500,000 retirement portfolio. That means his annual bill will be $7,500. Invested in a low-cost index fund portfolio, the actual management of your portfolio will cost about 0.1 percent a year, or $500. Equally important, this portfolio is likely to provide a better after-expense performance than 70 percent of the actively managed portfolios.
The cost difference here is $7,000 a year. You should be able to get a whole lot of financial planning done for $7,000. If you figure a (hefty) billing rate of $250 an hour, you should get 28 hours of your planner’s undivided attention. That’s a lot of time, more than most people need.
This is why I have long believed that financial planning and investment management should be “unbundled” — they should be delivered a la carte.
If you are a small-business owner or the fortunate recipient of generous stock options, having a financial planner on retainer is a good idea. You will probably need help every year working through some complicated tax and allocation decisions. But if you are a working stiff — even a well-paid working stiff — you’re not going to need to pay more than 1 percent of your assets every year, for life, to make personal finance decisions.
Q: How should an 18-year-old invest a lump sum of $10,000? Teenagers starting out need special help. What do you suggest?
A: Many years ago a friend of mine was eager to go to his 25th prep school reunion. He was most curious about one classmate whose stated ambition was very specific: He wanted to become a senior partner in a medium-sized accounting firm in Newark, N.J. My friend wondered if anyone could actually follow an ambition that specific.
Well, guess what? His classmate had become a senior partner in a medium-sized accounting firm in Newark, N.J.
If your 18-year-old is of similar nature, then he can follow the conventional wisdom and put every dime of that $10,000 in the stock market. The idea is that each dollar invested today is likely to be worth about $128 about 50 years from now.
Real life, however, varies. So do real 18-year-olds. If your 18-year-old is pretty serious and has a good idea of what he or she wants to do, then investing in a broad stock fund, such as the Vanguard Total Market Index ETF, would be entirely reasonable.
But if there is a small chance that your 18-year-old will have some uncertainties of profession, fail to marry well, face a decaying economy, or simply opt for a year or two of travel and identity crisis, he or she would be better advised to invest in a simple, low-cost balanced fund. The one I mention most is Vanguard Balanced Index. Balanced funds are mixtures of equities and fixed-income. They fluctuate less than all equity funds, so if there is a need to sell in a down market, the damage may not be so great.
Questions about personal finance and investments may be sent by email to scott@scottburns.com.