The selling of inexpensive, computerized investment advice should be like shooting fish in a barrel if what I see from the financial services industry is any indication of what the major competition looks like these days. A typical account I just reviewed indicated that on a $100,000 account, a major bank’s “wealth advisory service” was charging 1.5 percent per year to spread a client’s assets over about twenty different mutual funds whose average annual expense ratios were three quarters of one percent per year. All told, the cost to the investor (both advice and fund expense) was well over two percent per year.
New, online services like Betterment or Wealthfront are charging 0.15 percent and 0.25 percent respectively for financial handholding that goes a long way toward duplicating or improving on anything the banks and brokerage firms are charging for their mutual fund selection services. Vanguard has an advisory service with someone you can talk to for as little as 0.30 percent per year. So, there are better alternatives out there, but the best approach might be a soupcon of education and a do-it-yourself (DIY) approach.
We’ll start with retirees who are attracted to these services more than nest egg builders. Retired folks are finally “alone with their money” as they shift gears from what has been a growing combination of 401(k)’s and roll-over IRA’s. They are now prompted to determine the best course of action for creating income from these assets. Anything they pay for advice --- from a fraction of one percent to over two full percentage points --- will come out of either their income or from annual earnings they could otherwise leave in the account to keep pace with inflation.
It wouldn’t hurt to review a little financial history to see how easy it can be to develop a DIY advisory service and effectively pay yourself what otherwise would have been spent for no value added.
A 20-year return of 60 percent stocks and 40 percent bonds has yielded an average of 9.35 percent per year. The annual 20-year average yield on a reverse of that mix was 8.47 percent. The financial press routinely suggests that 4 percent is the maximum amount anyone can safely extract from a nest egg and not run out of money in retirement. What that figure assumes is that everyone uses advice that costs, at a minimum, 1 percent per year. The figures quoted above are raw numbers that include stock and bond index funds over rolling twenty-year periods. There are no fees of any kind beyond 0.05 to 0.1 percent on the annual expense ratio of the typical index fund. This would be a cost of between $50 and $100 per year to do all the work on $100,000. The rest of those average annual returns cited above could all be inuring to the do-it-yourselfer!!
A cynic might suggest that the press, from MONEY magazine to the New York Times, depends to some extent on advertising revenue from the financial services industry. Therefore, their countless articles telling retirees what to safely withdraw will take into consideration the 1 to 2 percent skim off the top for their benefactors. Even AARP, the supposed champion of retiree well being, is in the mutual fund and insurance business so they don’t want to foul their nest either.
So the bottom line is that someone keeping life simple and cost effective can calculate what amounts to 5% of their account balance in bond and stock index funds at the beginning of each year. Divide that number by twelve and instruct the fund to deposit the resulting dollar amount automatically into a checking account each month. Most of the money deposited will be made up of bond interest and stock dividends, so the principal will remain largely intact. In fact, the 3 percent balance of the roughly 8 percent will continue to compound to protect against inflation. Just so you know, in tough years like 2002 and 2008, the heavier bond combination lost a temporary 4 and 9 percent respectively with an immediate snap back. No big deal.
Meanwhile, the DIY practitioner has just increased income by 25 percent --- from 4 percent to 5 percent --- and should never run out of money even when adjusting for inflation. As Ross Perot would have said, “It’s that simple.”