From 28 Funds to 3: Simplifying to a Three Fund Portfolio

In real life, I don’t talk about money with many people, but there is one retired couple that I discuss dollars with rather freely. In recent years, as I’ve broached the subject of early retirement, they’ve taken a little more interest in what I’m doing, and have taken a closer look at what they’ve been doing.

Contract DiagnosticsAs you might know, I am a Do-It-Yourself (DIY) investor. The man in the couple I’m talking about is a DIY master in many ways. He repairs things. He designs things. He builds things. Then he remodels them. He built a complete 24′ by 30′ workshop for the sole purpose of building more things. Above that workshop, he built an efficiency apartment, complete with dormers, a kitchen, and bathroom. It’s quite a place.

But he’s never been a DIY guy when it comes to money. He understands it well, and taught me some valuable lessons over the years. He was a business owner, and had to hire someone to manage his businesses’ retirement plan for him and his employees. After retiring, his retirement savings continued to be managed by the same financial advisor.

In the six or seven years since he retired, the company that managed his money was sold or merged with another company two times, but he kept the same advisor whom he had grown to trust. Rather abruptly this fall, his advisor resigned, and he was offered two new names from which to choose.

How do you choose an advisor? You can meet face-to-face with each and develop your own set of criteria. Do we share the same vision? Will he consider my input? Does he have enough gray hair? Do we share the same alma mater and root for the same teams?

Actually, a better place to start is by looking up the names on BrokerCheck by FINRA. That is what this particular gentleman did. Guess what? Neither of the two names had a clean record. One had been terminated for “VIOLATION OF A PROVISION OF THE FIRM’S COMPLIANCE POLICIES AND PROCEDURES.” I didn’t use ALL CAPS for emphasis – that’s just how FINRA states it.

The other (I’ll spare you the lengthy ALL CAPS) listed the following allegation: “Customer complaint alleges unsuitable purchase and sale of annuities resulted in undisclosed surrender charges and unforeseen tax obligations resulting in damages of approximately $37,000.”

Which advisor would you choose?

 

A Look at the Retirees’ Portfolio

 

In the past, I had casually mentioned to the couple that it wouldn’t be too difficult for them to manage their own nest egg if they had any interest. It would also save them some money, of course. How much? Well, we didn’t really know until we took a closer look at his current investments and fee structure.

The portfolio under the microscope consists of two tax-deferred IRAs and a joint taxable account. Fees consisted of the expense ratios of the funds, and a management fee that was believed to be 0.5%, which is what it was when they signed on.

Browsing through the 3/4″ thick packet from their most recent biannual meeting, we could see that the management fee (which was 0.5% six years and two companies ago) was now 0.73%. Funny — there was no recollection of that fee increase ever being discussed.

This is what they had in each of the accounts:

  • IRA 1 had 3.5% of the assets and held 16 different funds.
  • IRA 2 held 83.8% of assets in 22 funds.
  • The taxable account held 12.6% of the assets in 10 funds.

 

Since there was some overlap, altogether they held 48 positions in 28 different funds. Let’s take a look at the details.

 

 

I determined the overall allocation to be roughly 47% US stocks, 14% International stocks, and 39% bonds. I would consider that an appropriate asset allocation for a couple that would expect to live another 15 years based on actuarial tables, but possibly 20 to 30 years based on current health and family history.

I would also consider that to be a really complex and costly way to manage a 60 / 40 portfolio. I showed them my portfolio, and I shared with them these links on the three fund portfolio:

 

I offered my assistance in making a transition if they were interested, and gave them some time to mull it over.

They didn’t need much time.

When they came back to get the ball rolling, I showed them one more link and told them what I’d been up to in my spare time over the last year. That was a fun “reveal”.

 

The Proposed Fidelity Three Fund Portfolio

 

All three existing accounts (two IRAs and a taxable account) were with Fidelity. While I have mine with Vanguard, I had read about the recent lowering of fees in Fidelity’s index funds. Indeed, when I did my own discount double-check, the fees were a hair lower at Fidelity. I also realized the transition would be a bit quicker and uncomplicated by sticking with Fidelity. Furthermore, Fidelity has branches you can walk into, staffed by humans at desks, and you can sit across from them.

We decided to remain with Fidelity.

Our goals were to keep a similar asset allocation, rebalancing to 45% US stocks / 15% International stocks / 40% bonds using these three funds:

  • FSTVX — Total [US] Market Index Fund
  • FTIPX — Total International Index Fund
  • FSITX — US Bond Index Fund

 

Another primary objective was to reduce fees. Based on the existing average expense ratio of 0.64 and a management fee of 0.73%, their current fees were nearly $22,000 per year.

Switching to a three-fund portfolio using passive index funds to arrive at our desired allocation would bring the total annual fees under $1,000 per year, a savings of $21,000 per year. Of course, that $21,000 would be well spent if returns outpaced the indexes by at least 1.5% a year. The odds of that happening, and happening repeatedly, are exceedingly small.

Glancing through the investment performance packet, their portfolio had returned 2.2% over a trailing three year period net of fees. The same paperwork showed the S&P 500 returning 8% over that time frame (although it was actually 8.7% with dividends reinvested). International funds and bonds were relatively flat, but a 45 / 15 /40 mix would have returned between 4% and 5%, which looks pretty good compared to 2.2% (or 3.6% before fees).

 

This is what the proposed portfolio looked like.

 

 

We started with a call to Fidelity. The representatives were quite helpful, guiding us through the process of opening new accounts and transferring the money from the managed accounts to the newly created accounts. All of the mutual funds remained the same during the transfer.

Once the funds were in the new accounts, the fun began. I was the token oblivious loud guy on his cell phone you see on television. BUY!  SELL.  SELL!  BUY!  YES!  MORE FSTVX! I was doing it with a mouse and computer, and no one was listening, but I barked out the orders just the same.

Some funds could be exchanged for new Fidelity funds. Others had to be liquidated to cash in the account followed by purchases of the new Fidelity funds. Some settled more quickly than others. I logged in daily for about a week to mop it all up.

In the IRAs, we did not have to consider tax consequences. The taxable account was less straightforward. For better or worse, there were actually a number of funds with capital losses.

It’s worse because we did this with the market at record highs, and most of these funds had been held for some time. I was not expecting to see losers. It’s better because we were able to take some losses to offset the gains, exiting most of the mutual funds with minimal tax consequence.

In the end, we were left with two mutual funds with mostly long-term gains of about $15,000 between the two. To sell would trigger a taxable event to the tune of at least $3,000 due to capital gains and state income tax. They’re not particularly bad funds, and there may be an opportunity to unload them tax-free in the future, so we decided to leave them alone.

 

The Actual Portfolio Today

 

This is what the portfolio looks like now.

 

 

Not bad, eh?

 

That looks like a portfolio that can be managed by a Do-It-Yourselfer. The original portfolio before we tore it apart? That looks like something only a professional should mess with. I think that’s the point. It looks extraordinarily complicated, and it is, but it needn’t be. If it looked a whole lot easier, the professional wouldn’t be necessary.

Armed with a little knowledge and a willingness to stay the course through good times and bad, the individual can do this on his or her own. Of course, the typical investor underperforms the market by four to seven percent due to behavioral factors (buying high, bailing low), so there is a role for professionals for those investors who don’t have the knowledge or the fortitude.

The $22,000 in fees previously lost to the advisor and the fund companies represent at least a quarter of this retired couple’s annual spending. For every three or four dollars they spent as retirees, one dollar went to their advisor. And that’s considered normal and acceptable. I don’t like it.

Frankly, I’d be willing to bet the portfolio’s balances could be substantially larger if they hadn’t been nibbled at a little every year while they were growing. Remember, investment fees will cost you millions.

How can 1.4% in fees be so costly? Think of it this way. If you’re planning on the portfolio returning 3% to 5% with a conservative allocation to preserve capital, once you subtract the fees, you’re left with 1.6% to 3.6%. A sustainable withdrawal rate of 4% doesn’t look so safe after awhile.

With the new allocation, we didn’t quite get down to a three-fund portfolio, but nearly 97% of the portfolio is in one. We also weren’t able to get the expenses down to 0.058% or under $1,000, but we’re not that far off with a weighted ER of 0.081 and annual expenses of about $1,300.

I’d say we did pretty well.

 

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66 comments

  • Four funds is great progress, and an extra $21k per year should help any retiree!

    For my own retired parents, I went with the three fund strategy. Roughly half is in FSTVX.

    That, plus the two other funds should be more than enough diversification.

  • Bravo, PoF, what a great case study. It must be very satisfying to help someone improve their financial situation so mucn with so little effort. Congratulations!

  • Excellent work, POF. It astounds me that these advisers still get away with charging high fees, and while under-performing the market!

  • Good karma you earned there POF! Index lag is a real risk for most investors, even those who claim to be in index funds due to trading, taxes and timing attempts. I will cover this in my ongoing series on DGI vs. Indexing.

  • Nice job on helping this couple simplify their holdings and save money. That John Bogle was on to something with his index fund trick 😉 I talk with highly educated professionals at my job everyday who wouldn’t dream of managing their own money. When I tell them, “you know, you could probably just do it yourself”, I’m dismissed as being a silly woman who probably has no idea about her family’s finances. Ha! Makes me chuckle inside 🙂

    Mrs. Mad Money Monster

    • Silly woman. 🙂

      I suppose you’re right about the gender issue. I have read studies that show women take fewer risks with money, which is generally a good thing unless avoiding risk means avoiding the stock market altogether.

      I think many physicians think they need an advisor because doctor money is special money somehow. But our issues are no different than anyone else’s. Minimize fees, minimize taxes, time in the market beats timing the market.

      Cheers!
      -PoF

  • Great work and great progress getting to four. It’s usually an uphill battle getting people to pare down as they’ve had diversification beaten into them over a lifetime, and yet it’s hard to picture three funds as being just as diverse due to underlying holdings. Active versus index is also counterintuitive and even counter nature until you get into the details.

    • Thank you, FTF.

      Once you understand how diverse a three fund portfolio is, you quickly realize how unnecessary it is to own an extra 25 funds.

      My portfolio
      is a bit more complicated, but mainly out of necessity due to limited funds available in employer’s 401(k) and a desire to avoid duplicating funds in different accounts to allow for easy tax loss harvesting.

      Cheers!
      -PoF

  • It is pretty amazing that fees would account for one-quarter of their overall retirement expenses. No wonder all my hot shot friends went to work on wall street.

    It is even more amazing that people are tolerating this like they have no other choice. I just had a conversation at work yesterday with a colleague, dual physician couple, and they had already been through 2 advisors just based on personality conflicts but never did any due diligence on costs or competence.

    It is almost as if people choose a financial advisor as if they are choosing a lifelong friend.

    Great post, still getting back to zero over here!!

    • So true. Fees don’t matter all that much when you’re just getting started and have a 4 or 5-figure portfolio.

      By the time you’ve got 6 or 7-figures, fees start piling up, but it’s tough to leave your advisor when he goes to your church, has kids on the same ballteam, and buys you a nice dinner once or twice a year.

      I hope your colleague awakens to the idea that money management can be a pretty straightforward DIY project.

      Best,
      -PoF

  • Paul

    Great job on the fees. Yuge savings. In addition, investors need to monitor their funds’ performance, manager transition, % of cash they can hold per fund, Morning Star ratings, etc. With 30+ funds that is impossible. They probably filled their recycle bin with prospectus updates every year. Great job.

  • I agree, the advisor had them in a portfolio that is way too complicated and expensive. Simple is often the best route to take when it comes to investing. Unfortunately, not many advisors like simple. Yet they still get paid handsomely for underperforming.

    Nice job simplifying their portfolio, and especially cutting down fees. Such a killer on investment returns, especially as your nut grows. As you’ve shown here, investing doesn’t have to be complicated. A DIYer can take a much simpler approach and outperform many advisors, who regardless if they are a fiduciary or not, care more about making money for them as opposed to someone else.

  • Seems like a case where the finance adviser was doing what needed to be done to justify his fee! But that’s what many folks in that generation relied on. My parents were no different. Having 28 funds is well past the marginal benefit of diversification! Good for you for helping them out and hopefully others will slowly pick it up as well.

  • Great that you’re able to discuss finance with your friends. Not easy, especially if your friends think that you’re a baller “doctor”.

    I’ve been trying to pare down my funds to simply as well.

  • Nice job helping this couple. The data are quite clear that a simple, boring portfolio of low cost and diversified index funds is the best core investing approach. I recommend the same to most people, especially those that think they can’t manage their investments on their own (which is a surprisingly high number of people).

    Paying nearly 1% in fees when you have a sizable portfolio is crazy. I like to think of this (and have written about it in some detail) as a portion of expenses. If you have a portfolio of $1 million and are taking the standard 4% withdrawal, that’s $40,000. A 1% fee, that sounds small, is $10,000 or 25% of your annual spending money! Since it’s a percentage, a 1% advisor fee, is always 25% of your spending money (assuming you follow the standard 4% withdrawal rate advice). I’m not willing to pay this kind of fee or work 25% more years until retirement just to pay for something easily done myself. When you add the fact that advisors don’t actually beat the market and provide value, it’s even more crazy. Might as well take a huge pile of money into a field and light it on fire!

    • Indeed, IBFree.

      Realizing the incredible cost of fees on a 7-figure portfolio was an epiphany. Most (but not all, of course) physician couples will need at least $2 million to $3 million or more to retire comfortably while maintaining their lifestyle.

      Many will be paying more in fees to an advisor as retirees than they were paid as interns and residents working 80 to 100 hour workweeks!

      Best,
      -PoF

  • If you’re paying someone, they gotta make it look complicated at least. This must have been like powewashing some dirty siding. So much fun seeing how much you’re cleaning up!

    Nice work, I hope he got you some good beer 🙂

  • TheGipper

    Bet it feels nice to have such an incredibly positive impact on someone’s life and the well-being of their kids!

    I’m a libertarian and not one that is much for federal fiduciary rules, but I’ve often thought that paid advisors should have to present clients with their own updated personal portfolio and expenses prior to recommending one to their clients. Would be enlightening.

    • Well, they’ve got great kids. I can’t deny that. But I don’t think leaving a legacy is part of their plans. They’ve earned the money; I expect them to enjoy it.

      Advisors’ portfolios may not look that much different from their clients, but it would be enlightening. I’m reminded of the Upton Sinclair quote, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

      Cheers!
      -PoF

  • This is awesome PoF – paying that much in Fees makes me sick. Glad you could help out and make a manageable situation moving forward.

    That was an incredibly complicated portfolio for 99% of Americans. Seems like they spread it out for the sole purpose of doing so – also, glad to hear they were willing to let you help!

    • Thanks, AE. I didn’t want to push them into doing something different. I suggested it casually, and eventually they came to me looking for a little help. I made sure it was their decision to move the money, though.

      Cheers!
      -PoF

  • Great work PoF! I try to help others streamline their finances as well, if they want help that is 🙂

  • Oooh, thanks for the good info!

  • Nice stuff, PoF!

    Although I don’t especially care for some of the “traditional” portfolio allocations for retired folks, the new portfolio is at least $20k better per year than the old one!

    Fees like that are totally nuts when investors can basically track the market for free. How long before most financial advisors go the way of the dodo?

    • The way of the dodo, or the way of the robo.

      The new fiduciary rule is going to make it tougher for the disguised salesmen, but as this post illustrates, you can still meet a fiduciary standard while charging quite a bit of money and constructing an awfully complex portfolio.

      Best,
      -PoF

  • Karma++ PoF!

    That was a very satisfying read. Advisors who prey on the elderly and the vulnerable should go straight to purgatory. Do not pass go. Do not collect $200.

    • While I agree with you, Mrs. BITA, I don’t think this is a case of preying on the elderly. This couple just turned 70, are as sharp as they’ve ever been, and have been with the advisor for years.

      Also, they might read this, so I should point out that the couple is very generous, good-looking, and make a mean prime rib.

      Cheers!
      -PoF

  • I love it when a blogger gets a chance to really help someone. Great example of putting your talents to use for good. Great story. Crazy how complex his portfolio was before implementing your simplification plan.

  • Nice work. Maybe we can expect a DIY builder guest post from him. That would be cool. Probably in the next year we will be converting the kitchen hardwood floors to tile.

    My portfolio is a little more complicated, but about half is in low fee ETFs. I hold about 10 stocks individually.

    cd :O)

  • Great job! It’s really great that you were able to help out some real people.
    The financial advisor industry is fleecing older customers like these folks. It’s much easier to go with Vanguard or Fidelity. They also have financial advisor who are less bias.
    This kind of low cost index funds portfolio is easy to understand and manage. Perfect for retirees.

    • Thank you, Joe.

      I think people of all ages are being fleeced, but it’s at least partially by choice. We all have access to the same books, sites, and podcasts. When you choose not to educate yourself, you set yourself up to pay those fees.

      Best,
      -PoF

  • Strong work, PoF. And I thought my wife’s old brokerage account was bad. Good idea not to sell the funds with the large capital gains at the moment. Anyways, it seems like those two funds are a small percentage of the overall portfolio, so at least there isn’t too much drag when it comes to their fees.

    • Thank you, SRGO.

      I think it makes sense to hold onto them, at least for now. If we see a bear market soon, there may be an opportunity to offload them with little consequence, and if they need cash from the portfolio (beyond RMDs), those funds would be a good place to get it.

      If they hold onto them forever, there should be a stepped up cost basis when passed on to beneficiaries. Of course, the law could change between now and then.

      Best,
      -PoF

  • Nice work, PoF!
    We too shudder every time we think about when we got this close to signing up for the 1% AUM fee plan.
    I’m sure your friends are very appreciative.

  • Nice work PoF! It’s awesome that you were able to help some real friends out. Thanks for sharing your experience. It’s inspiring.

  • John

    Why did you go with FTIPX vs something like FSGDX?

  • Great job, PoF! It’s insane how financial advisors can charge so much when doing it yourself would be so much cheaper!

    I should probably advise my parents to move into their holdings into a 3-fund portfolio as they aren’t that great with their finances.

    • Thank you, SP.

      You could certainly suggest it if the topic comes up. Keep in mind, though, that it should be their choice. You can lead them to water, but let them decide whether or not to take a drink.

      You don’t want the next bear market to be considered all your fault.

      Cheers!
      -PoF

      • You’re definitely right on that, PoF!

        I’ll bring it up in discussion and if they are interested and willing to hear it out, I’ll help them along.

        Wouldn’t want them to pin the blame on me if something bad happens. 🙂

  • This is excellent. It is amazing to me that people are still paying high expenses on their investments. I feel like I live in a bubble where that problem was solved for everyone in 2004 ;-).

    Can you (or are you) keeping track of the old portfolio and expenses for comparison sake?

    • Excellent question, LM&M.

      I hadn’t thought about it, but it wouldn’t take long to do since I’ve already set up the Excel file listing everything. I could plug in the returns at the end of the calendar year and make a comparison.

      That would be a good blog post for next year at this time.

      Cheers!
      -PoF

  • SM

    We were just offered 0.4% AUM for full service advise from someone we had worked with for a couple years and really like the overall approach/philosophy. Previously it was 1%. The reduction came about when we were considering stopping the service or going with a fee-only advisor. We are in very low 7-figures, which at 0.4% is still not a small absolute number. However, I thought it is rather competitive, even comparing to some robo-investors. Certainly we can do a simplified version of 3 or 4 fund investment (what we started with before being sucked into having an advisor prior to reading blogs like this a few years ago) and manage it ourselves. Does anyone think there may be any advantage that will justify at 0.4% fee going with an advisor in terms of streamlining allocation across different taxable/tax advantaged accounts? Specially considering to simplify our accounts will involve selling and paying highest bracket capital gains, at least in the taxable, as we are still working full time in the accummulation phase. One consideration is to simplify and not need an advisor once in the withdraw phase and need to sell anyways. The advisor fee would be a greater proportion of income (presumably 4% withdraw) in retirement compared to now.

    • That’s an individual decision, and the amount of value you get from the advisor will be inversely proportional to the amount of time you spend to understand personal finance yourself.

      0.4% is relatively low, and you’re right that it’s not much more than the 0.25% and more charged by the robo advisors. Vanguard’s advisory fee is 0.3% and they give you predictable advice.

      With your current nest egg, 0.4% might be $5,000 a year. If you retire with $3M or $5M, then you’re looking at $12,000 to $20,000 a year. Only you can decide if that’s worth it to you.

      Best,
      -PoF

      • SM

        Thank you very much for the reply. I think a huge hesitation of leaving the current advisor is what to do with current accounts, especially the taxable (about 600-700K right now). What do you think is the best way to cash out of current holdings in a taxable account given the tax consequences if we are still working (for at least another 10 years or so) and are in the highest marginal bracket? Or do you leave the existing accounts and start a new simplified 3 fund account (which then will add to the complexity)? Or wait until a year without any earned income?

        • Sure, no problem.

          I can’t give you an opinion without knowing more about what’s in taxable, what your state taxes are, how long you anticipate it might be before you stop earning a wage, etc.. I did talk a bit about how I dealt with suboptimal funds in taxable in this guest post at WCI. The balance was about half of yours.

          I would suggest you post on Bogleheads and / or WCI Forum and crowdsource some opinions. Post which funds you have and the dollar amounts or percentages of each, marginal federal and state tax rates, and a rough time horizon to retirement and lower taxation. You’ll likely get dozens of opinions from people who live and breathe this stuff.

          Best,
          -PoF

  • This is such a great article! Great to see you were able to help this couple simplify, and more importantly save a ton of money. They’ll probably end up with better market performance going forward as well. It’s a bit sickening that so many people out there just have no clue about how simple it can be (should be) to invest and how they are thus prey to the financial industry that convinces them they need more complexity and expensive advisers. Thanks for a great write-up and real world example!

  • I am SOOOOOOOOO with you on this one. I also reviewed the opportunity cost of a 1% financial advisor and was astounded at the long term costs. The worst part was that he was basically putting me into a strategy that I was already employing. You can read about it here if you like.

  • Michelle Murphy

    Thank you for showing us what financial advice of this cost will actually buy!! I was wondering myself….

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