Investment management used to be for people with a lot of money that needed help to manage it. Not any more. With greater responsibility for our future needs, evolving markets that increase available investment opportunities, and technology that has lowered the cost of investment management, the service now makes sense for most people. We review some good reasons why you should let a professional manage your investments, even if you already know what your asset allocation should look like. The value of professional investment management can be well above its cost, and its cost can be well below the cost of not using the service.
Sometimes I get this question from our financial planning clients: “once we make our investment plan, can I manage the investments myself and just review it with you in our annual comprehensive plan review?” The answer is yes you can, but you have to be prepared to do quite a bit of work. Managing your investments is a bit like car maintenance. You have to keep your engine running smoothly and efficiently, so you can make sure you get to the important places you want to go to. Do you do your own car maintenance?
The engine of your growth
Your investments make up the engine of your plan, helping you move forward and towards your goals. So it is important that they are selected strategically to maximize the likelihood of achieving your goals while managing key risks. And equally important, investment selection is a dynamic concept. Your investments need regular review and evaluation. You can’t just set them and forget them. Your life, goals, risk tolerance, risk capacity, tax situation, and asset allocation change over time, and these changes need to be reflected on your plan. Even if you expect nothing to change in your life this year and hold passive funds, your asset allocation at the end of the year will be different from the beginning of the year, due to differences in performance across your investments. And keeping your investments in sync with your goals isn’t just about making sure your asset allocation is kept in check.
In this post we review some good reasons why you should let a professional manage your investments, even if you already know what your asset allocation should look like. And while quantifying the benefit is not always easy, the value of investment management services can go well beyond its cost, just in terms of time, effort, and peace of mind.
Select investments tailored to your goals
As a fee-only financial advisor and fiduciary, we aim to select the best investments for your plan. We make sure that our custodial partner has a complete selection of funds to implement our clients’ plans in a cost effective way, balancing costs and benefits of each investment option. We research the funds we select, and build model portfolios suitable for each individual client and goal. If you decide to manage your asset allocation on your own, you are restricted by the options available to you, the amount of research time you elect to devote to building and maintaining your allocation, and your investment expertise. Your old 401(k) plan may have limited investment options. And if you decide to roll it over to an IRA, which provider should you choose? How do you navigate across thousands of funds? Do you understand the risk and return properties of each fund? Think about time, energy spent, and peace of mind.
Optimizing your growth engine
Say your asset allocation is a mix of 60% stocks and 40% bonds. How do you build this allocation? Which investments go in the 60% stock bucket, which ones in the 40% bond bucket?
For your 60% bucket, you can use a simple index fund, tracking a world equity market index. But is this the best way to get that exposure? Index funds have low expense ratios but may have other costs in terms of performance and missed opportunities. Can we use more information than a simple index in building our portfolios? For example, research shows that like with everything else, the price and quality of a company matter for future returns. Research also shows that small companies are generally riskier and, historically, have yielded higher returns than large companies. So there are measurable quantities that can help us understand how to combine stocks in a portfolio. Using this information when combining your investments can help you achieve higher returns for a given level of risk.
And your risk management too
And it’s not just about stocks. Returns on bonds too are related to measurable characteristics, like the maturity of each bond and the creditworthiness of each issuer. You can use these characteristics to design a bond allocation that best manages the risks for your goals. For example, longer maturity bonds and bond funds can be used to manage income risk, while shorter term bonds can be used to reduce the volatility of your portfolio, or for goals that require capital preservation, like a safety net or a cash reserve. Corporate bonds and bond funds can be used as additional diversification and to increase the yield of the bond bucket in a mix of stocks and bonds.
(Tax) Location, location, location
For our 60/40 allocation example, should we just replicate the same asset allocation in each type of account, including taxable, tax-deferred, and tax free? How do you decide which investments should go in taxable ones vs non-taxable one? Old wisdom is to put stocks in a taxable account and inefficient bonds in tax advantaged accounts. Unfortunately, this old wisdom is just that, old. What matters to investors is how much wealth can be generated, after all taxes, over the investment horizon (including liquidation taxes at the end). Net wealth depends on tax efficiency and on expected returns. Not all stocks and bond investments are the same in terms of tax efficiency and expected returns. For example, emerging market stock funds are generally less efficient than US stock funds. Letting some of your high growth assets grow tax free may generate more wealth than relegating them to taxable accounts. We use technology to continually evaluate tax tradeoffs and implement a tax-coordinated portfolio.
Tax loss harvesting
Tax loss harvesting (TLH) is the name for a strategy that uses investment losses to reduce taxable investment gains and other income, potentially yielding greater after tax returns. With this strategy, when an investment loses value, it is sold and replaced with another investment. With the sale, the loss is realized and can be used to offset taxable gains and other income. The replacement investment makes sure the portfolio stays well diversified and maintains the desired asset allocation (in terms of cost, liquidity, and behavior). An illustrative example can be replacing the Vanguard Value ETF with the iShares S&P 500 ETF, or vice-versa.
Many investors relegate tax loss harvesting to once a year, typically towards the end of the year. But, since relatively large losses and gains can occur throughout the year, tax loss harvesting should be a regular consideration. Each of your contributions, for example, create loss harvesting opportunities, because the price of an investment at any given time can be compared to the price you paid when you contributed to it. For some of the portfolios we create, we can use intelligent technology provided by our custodial partner Betterment to regularly scout for TLH opportunities.
Smart Rebalancing
Because of performance differences across investments, your asset allocation will drift from its target over time. Depending on market movements, the drift can be large even in relatively short periods of time. So it is important to monitor your performance and make appropriate changes to ensure your asset allocation is always consistent with your objectives. Because changes in asset allocation may involve costs due to trading and taxes, it is important to consider these costs before making any changes. The best way to reduce potential tax liabilities is to allow for small deviations from the target asset allocation, and use planned contributions to rebalance towards the target. Monitoring the allocation and rebalancing regularly this way can reduce the likelihood of bigger changes down the road, which can result in larger taxes and other costs.
Advisor Guidance
We focused above on tangible benefits that can directly affect returns. But the value of having an expert manage your investments does not end here. Besides the time and effort saved by delegating this task, working with an expert brings the benefit of peace of mind. Think about the questions we have just considered.
- How do I invest my savings?
- Am I managing my risks correctly?
- Am I appropriately considering the effect of taxes on my portfolio?
- Should I worry about what’s happening in the market this week?
- How do I know when it’s time to make a change to any of these things?
These are real questions investors routinely ask. Do you have peace of mind, knowing you are making good decisions in the above areas? Having these questions linger without expert help can increase your anxiety, and that can lead to suboptimal investment decisions.
Will you stick with it?
So you have a plan, you are ready to tackle the questions above. You think you will do your research, spend time selecting portfolios, think about taxes, review your investments periodically to rebalance and harvest losses. It may not be as good as working with an advisor, but close enough, and you can avoid advisor fees. But, will you do it? Before you answer, consider this related question. Have you been doing it?
Avoiding big mistakes
Advisor guidance can help you avoid investment mistakes, like that costly variable annuity, the active funds your neighbor suggested, the investment in pets.com you just had to have, or getting out of the market because you read it on Money.com. Without a real advisor, we may seek guidance in the wrong places, including self-proclaimed experts in the financial news, and may be subject to fads and herd behavior. How well can you behave?
The Power of Goals Based Investing
Remember why you are doing this. Your investments are the engine to help you achieve your goals. Your goals, when properly defined, are the why of your plan. Moving closer to your goals can make you feel good about the efforts you make to realize them, increasing your life satisfaction. And by appealing to our aspirational nature, focusing on our goals can help us find the strength to overcome setbacks. We use a goals-based approach both when we design your investment plan, and when we manage your investments. Our technology allows us to assign investments to different goals, so performance can be evaluated in a meaningful way, by measuring progress towards your goals, and not just in terms of total returns.
There are many ways in which having an advisor manage your investments is beneficial to you, from the tangible benefits in terms of potential performance to the less tangible, but even more important benefits of saved time, energy, and peace of mind, which you can use for other things that matter to you. Estimates of the measurable benefits vary, but a simple analysis by Vanguard shows that advisor guidance alone can improve returns by 1.5% annually, a value greater than the average cost of a fee-only advisor (Vanguard estimates the total of the services we discussed to be between 2% and 3%). The benefits of extra time, energy, and peace of mind? Priceless.
So don’t wait, talk to us about our investment management services.
Until next time!
Massi De Santis is an Austin, TX fee-only financial planner. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.