Whether advisors are “fiduciaries” doesn’t matter. How much they know does.
Is your money manager a fiduciary or a non-fiduciary? The question has given rise to a titantic legal and political battle over the past year. I think it’s beside the point.
I have an entirely different taxonomy for the experts who tell you how to invest. Study my six-way classification. It could save you a ton of money.
Some of these six categories have venerable histories stretching back a century or two; one is younger than the Internet. Three—the last three below—I would unhesitatingly recommend to a friend. The first three are more problematic, although right for some people.
1. The Gladhander. A stockbroker is, above all else, a salesman. He or she may be clueless about why Roth conversions usually make people better off and utterly at a loss if asked to calculate the taxable equivalent yield on a muni. But this species of money manager is good at landing new clients.
I recently listened to a financial planner explain why she left a big brokerage to work at a small firm. Her analytical skills were not appreciated at the broker’s office. There, she said, the advisor with the biggest income was someone who struggled in college—landing an arts degree after seven years at a third-tier institution—and knew nothing about finance. But he had a winning smile.
For most of the 20th century, these characters made their living off fixed commissions buying and selling stocks. A flurry of trading slips would be enough to extract 1% or 2% annually from an account. The unfixing of trading commissions in 1975 ended that game. The stockbrokers scarcely suffered, though. They just switched to selling financial products (like annuities) that paid sales commissions.
The pending rule on fiduciary behavior for retirement accounts would make it harder to collect product commissions. But the gladhanders can handle this transition as easily as they did the last one. They’ll just collect asset management fees instead. Expect 1% to 2% annually.
Should you use this kind of wealth manager? Only if you don’t need advice that demands any financial analysis.
2. The Stockpicker. This person earns a fee for selling the bad stocks in your portfolio and buying good ones.
The money geniuses of yore, like Benjamin Graham (1894-1976), Philip Fisher (1907-2004) and John Templeton (1912-2008), were pickers of stocks. They weren’t financial planners.
Today, you can find plenty of vendors selling portfolio expertise, directly and via the “separately managed account” services of brokers, with whom the fees are split. But don’t think you’re likely to land the next Templeton.
Some stockpickers will prove, after the event, to have more than earned their cost by beating the market. But you don’t know which ones. Past success being only a feeble indication of future results, it is next to impossible to know in advance which portfolio advisors will succeed.
You do know, in advance, that stockpickers as a group provide no value at all. The outperformance of one is necessarily matched by the underperformance of another. Therein lies the explanation for the migration of several trillions of dollars away from active money managers to the cheap index funds offered by Vanguard and others.
3. The Percentage Planner. This species of advisor collects a percentage of your assets in return for advice on saving and spending: mortgages, college accounts, retirement and so on. A fee of 1% annually on the first $1 million, and less on larger sums, is typical.
The good players have credentials like “certified financial planner,” a designation belonging to roughly a fourth of the country’s financial advisors. That means they know more than gladhanders. (You can search for CFPs here.)
Are such planners worth the money you pay them? They have a perhaps surprising advocate in Vanguard, the company that wrecked the careers of stock-picking brokers with its index funds. Vanguard talks about “advisor alpha,” the performance boost delivered by planners not by beating the market but by defeating clients’ emotions. They keep fools from buying during times of exuberance and then panicking during crashes. Alpha also comes from wealth planning (mortgages, etc.). In Vanguard’s analysis, advisors’ alphas more than pay for their collective fees.
I agree with Vanguard’s conclusion, but I think that for most people the next category offers a better buy.
4. The Hourly Planner. You pay your lawyer and your CPA by the hour. Why not your financial planner?
In 2018 I profiled Allan Roth, a Colorado Springs, Colo. planner who gets $450 an hour. A client with $10 million of assets and modest complexity in his affairs might be billed $8,000 the first year, and less afterwards. That’s vastly less than any percentage manager would charge.
Alas, hourly-rate advisors are as scarce as lottery jackpots. When people ask for a recommendation, I have little to offer besides Roth, whose waiting list is several months long.
I’d like to hear from other planners who bill exclusively, or almost exclusively, on an hourly basis. If you are such an advisor, send a note, including a link to your website, to williambaldwinfinance-at-forbes-dot-com.
5. The Robot. The internet has given rise to an assortment of firms that do portfolio construction with software. Examples: Betterment, Personal Capital, Rebalance IRA, Charles Schwab (in its Intelligent Portfolios service) and WealthFront. Sometimes the robo-advice is coupled with a little human intervention. Annual asset fees are as low as 0.25% plus the small expense ratios inside the exchange-traded funds used.
Worth it? Yes, for your taxable accounts. If you sign up for loss harvesting, there’s a good chance the tax benefit from capturing capital losses will exceed the fee you’re paying.
For retirement accounts, where loss harvesting is not an option, the case for robo-advising is less compelling. You might do better assembling a nicely balanced collection of ETFs on your own. Here’s my 4-3-2-1 plan: 40% in Vanguard Total Stock Market (VTI), 30% in Schwab U.S. Aggregate Bond (SCHZ), 20% in Vanguard Total International Stock (VXUS), 10% in Vanguard Corporate Intermediate Bond (VCIT). (See The $1 Million Retirement Plan.)
6.The Trustee. The day will come when you are incapable of handling your finances. Who signs the checks to the nursing home? You can arrange in advance for a bank or other fiduciary to step in when needed. A trust document spells out the trigger:
for example, when three named people (say, a child, a lawyer and a doctor) vote to take away the keys to the brokerage account. At that point the fiduciary will take the reins, levying fees that will be high but very justified.