When Rick Ferri, financial advisor and founder of Ferri Investment Solutions, recently looked at a new client’s portfolio, a familiar image came to mind. Comic by retirement planner Aaron Brask featuring Humpty Dumpty.
In it, the intact egg on the wall is labeled as a total market portfolio with an expense ratio of 0.04%. A nefarious financial planner appears who pushes Humpty off the wall. When he sticks around again, Humpty is now made up of several types of investments rather than one fund.
Advisors now call Eggs a “diversified portfolio” and charge 1%.
This may not be the funniest comic in the world, but it’s one worth paying attention to, especially if you’re working with a financial advisor. What’s described in the comics and what Ferri sees in client portfolios is all too common in the world of financial planning. Advisors justify high fees by making simple strategies look complicated.
“Complexity is the stability of an advisor’s job,” Ferri told CNBC Make It. “Don’t be too low on funds because clients will realize they don’t need you anymore.”
Here’s how to know if you’re in the “Humpty Dumpty Portfolio” and why it’s imperative to keep your investment costs as low as possible.
What is the “Humpty Dumpty Portfolio”?
Financial experts generally dictate investing in low-cost, widely diversified portfolios. One easy way to achieve this is Index mutual funds or exchange-traded funds that track and attempt to match the performance of market benchmarks such as the S&P 500.
For example, if you buy a so-called “Total Market” ETF, you will have exposure to a portfolio representing the entire investable US stock market. Vanguard’s annual cost is just 0.03% for that version.
If you own both stocks and bonds, you can use four funds to build a well-diversified portfolio: one holding U.S. stocks, one holding international stocks, one holding international stocks, Ferri said. The other is US Treasuries and the other is Foreign Bonds. “One or two funds can even do the trick,” he says.
In his consulting practice, however, when fellow advisors seek Ferri’s help in building model portfolios, they rarely want to keep things so simple. “My first question is, ‘What is the minimum amount of funds?'” he says. A common answer among advisors is “At least 8. No more than 12.”
The name alone is enough, so when investors look at the portfolio, I think they’re getting a complex strategy. In practice, large areas of the market are often divided into smaller pieces. Putting those pieces back together (with or without the help of all the King’s Horses) gives you exposure to the same broad market indices, just at a higher price.
Overall stock market funds can be divided into two camps: growth stocks and value stocks. Alternatively, it can be split in three ways: small, medium, and large company shares. Using just these two parameters, one diversified index fund can be split into six smaller funds. Overall, the exposure to the market may be exactly the same, only it looks more complicated.
Ferri says the best way to tell if you’re in such a portfolio is if you own two “halves” of essentially the same index. “If you see a lot of growth and a lot of value and both funds have the same amount, you know it’s BS,” he says.
Why You Don’t Need a “Humpty Dumpty Portfolio”
Even if you have a “Humpty Dumpty Portfolio”, you may still be doing many things right, and may be widely spread across a series of low-cost investments.
There’s nothing wrong with paying and letting someone else run the business of investing, but think about how much you’re paying.
Many advisors who manage client investments charge an annual fee equal to 1% of the client’s invested assets. It may not seem like a big deal now, but remember. Every dollar you pay in fees is money that could have multiplied with your investment. Over the course of your life as an investor, it can add up.
Let’s say you invest $10,000 in an equity ETF with an annual cost of 0.03% and get a 7% annualized return. After 45 years, your funds are worth over $207,000 and you have paid a total of $908 in fees.
Now suppose you get the same return on the same investment, but pay a 1% fee. At the end of 45 years, advisers told him he forked over $22,000, so he has less than $134,000. It doesn’t even count the fees that the funds you hold charge you.
We are not saying that advisors cannot provide useful investment guidance. However, consider your options before handing a portion of your money to someone who is duplicating a strategy you created yourself.
One solution: Find a planner to look at your portfolio for a one-time fee. “Maybe you just want to have a conversation with an expert to make sure you’re not off track,” Ferri says.
Alternatively, consider an advisor who offers a monthly subscription model. “Sometimes we need validation,” he says Ferri. “It might be worth paying a flat monthly fee to have someone available when you need it.”
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