This story appears in the July 25, 2016 issue of Forbes. Subscribe
Retirement savers: If you don't have a fairly precise idea of your number, you'd better work on getting it. I'm not talking about the number of dollars you're planning to pile up by age 66. I'm talking about the dollars you spend every year on money management.
Look for the number on the year-end statement from your financial advisor. It adds up five things: the percentage asset fee (if any), loads paid to buy investment products, expenses built into products you own, the 20% incentive fees buried inside your hedge funds and the market impact (bid/ask spread) of securities trades that you made or that were made on your behalf inside a fund.
Oh, dear. The number is missing? Doubtless the brokerage is planning to add that sometimes embarrassing disclosure to its reports. But its IT department is tied up at the moment.
So come up with the number yourself. I'll show you how by figuring the costs incurred by one saver who shared a portfolio spreadsheet with me. X, as I will call him, is an engineer in his 60s. He has $1.1 million with a large and reputable brokerage firm. (He has a lot more in employer retirement plans, but they won't be part of this analysis.)
The brokerage account consists of a bit more than $900,000 in tax-deferred IRAs and the balance in money markets currently earning nothing. The whole pot is subject to the broker's 1% asset fee. So we're starting with $11,000 in annual costs right there.
The IRAs are invested in an assortment of individual stocks plus a blizzard of mutual and exchange-traded funds. For each fund position I multiply the dollar amount by an expense ratio pulled off Morningstar.com. I assume, charitably, that neither the money markets nor the individual stocks have any transaction or other costs associated with them.
What about the trading costs incurred by funds? These are a matter of some debate, but I think a conservative estimate is that trades cost 0.25% round-trip on average. For a fund with 100% turnover, then, you could add 0.25% to the Morningstar expense ratio. X's broker, mercifully, selected funds with fairly low turnover, so trading has not made a big dent in X's net worth.
When I add up the indirect costs (fund overhead and fund trading) in the brokerage account I come up with $3,600. So X is losing $14,600 a year to money management.
And what does he get for it? Clutter. X owns 21 funds. This messy amalgam accomplishes nothing that could not be achieved with three cheap index ETFs (holding bonds, U.S. stocks and foreign stocks). Individual stocks? They make sense in a taxable portfolio, where you can extract capital losses, but no sense in a tax-deferred account.
I can guess why the broker came up with the busy portfolio: to attach a fireworks display to what is a trivial assignment, namely, identifying the three index funds. You don't need to pay someone $11,000 to do that.
Some financial advisors earn their keep. They design retirement and estate plans, calculate the optimum amount of your IRA to Rothify, find ways to extract state tax benefits from college savings without giving away too much in fees, help you arrange your assets so that they are not damaged by college-aid formulas and find tax-smart ways to liquidate appreciated assets.
What are you spending on financial advice? Get out your Excel and do the arithmetic. Now assign a value to the tax-cutting and other tips you're getting. The correct value to assign to security selection is zero.
The index portfolio for your retirement account, if you are past middle age: 40% each in Schwab U.S. Broad Market (SCHB, 51) and Vanguard Total Bond Market (BND, 83), and 20% in Vanguard Total International Stock (VXUS, 46). The annual cost, per $1 million, is $620.