Top 5 Ways to Manage Your Money

I’ve written a few Top 5 posts so far, and the 5 top items have generally been listed in no particular order. That won’t be the case today. Presenting, from best to worst, the Top 5 ways to manage your money:

 

1. DIY (Do It Yourself)

 

M.D. Financial Services

Invest in low cost stock and bond funds. Diversify. Invest early and often. Know the tax implications. Create an Investor Policy Statement with a thoughtful asset allocation for your portfolio. Read a recommended book or three. Avoid costly mistakes.

Acknowledge that you don’t know what you don’t know, like the future for example. Educate yourself. Understand that time in the market beats timing the market. When you have a question, you ask it in the Bogleheads Forum and get free advice from intelligent and experienced investors, several of whom have published successful investment books. To get started, see my comprehensive 20 Steps to Effective DIY Investing.

 

 

2. Tie (RoboAdvisor, hourly rate financial advisor / CFP)

 

Either an hourly rate financial advisor or roboadviser, such as Betterment or Wealthfront can supplement a DIY approach. I’m calling it a tie, although there are certainly pros and cons to each. The theme of this list is going to be lowest cost to highest cost. Which of these comes out ahead depends on your net worth, since the roboadvisor will charge a very small portion of your invested assets, while the hourly rate advisor will charge… wait for it… wait for it …an hourly rate.

If you choose to go either route (or both as they are not mutually exclusive), you had better have at least a basic understanding of your finances. You don’t have to be as well versed as the 100% DIY investor, but you need to know enough to understand what’s going on with your money. The human is going to be better able to talk you through this compared to the robot.  The robot might be a better dancer.

 

3. Fee-only financial advisor

 

Consult with a fee-only advisor with a fiduciary responsibility. Such an advisor may charge an AUM fee (Assets Under Management), which can really add up, particularly when you have a high enough net worth to retire. On the plus side, a fiduciary is required by law to disclose any conflict of interest and has a “duty to care” about your portfolio and it’s appropriateness. The advisor will not be paid commissions and the products you purchase ought to be low cost. Your incentives are aligned. As your net worth grows, the advisor’s fee typically grows right along with it. This is a reasonable option for someone who likes to be more hands-off when it comes to personal finance.

Ideally, you will like this advisor as a person. You will be contributing handsomely to his or her retirement. A $3 million dollar nest egg with a typical 1% AUM fee generates $30,000 a year for the advisor, and comes directly from your retirement stash. Think about that.

 

4. The friendly downhome / advisor / planner / “money guy”

 

Invest with the friendly neighborhood insurance salesman fee-based financial planner, or whatever designation they are going by these days. This is an individual who does not have a fiduciary responsibility, but is held to a “suitability” standard, which is much less rigorous.

Expect to be pitched whole life insurance and annuities. You can expect to be invested in “suitable” mutual funds with high expense ratios, 12b-1 fees, and perhaps a front or back load. The layer cake of fees may also include an AUM fee, and you can expect to pay a fee to transfer your money out when you realize that half of your investment gains are going into the smiling advisor’s pocket.

It can be hard to say “no” to this person.  He’s your son’s soccer coach.  She helped organize the church bazaar.  He was a drinking buddy in high school college, although it took him six years to graduate.  And he’s a good salesman, which is what makes him successful.  You can do worse than to sign on with her, but you can do much better.

 

5. DIY (Do It Yourself)

 

pof’s diy under deck patio

 

Invest with emotion. Get in while the getting’ is good (buy high). Get out when the bottom drops out (sell low). Put all your eggs in one basket, and perhaps take on debt to put a couple of someone else’s eggs in there on margin. Buy the stocks recommended by the loud man on the television.

Pay for the newsletter and buy the sure-things recommended there. Chase returns. Worry not about tax implications. The rich need to pay their fair share, and you’re a hot streak away from being rich. Invest in your buddie’s latest business. He’s due for success this time.

I kid, but studies have shown that the average investor underperforms the indexes by 4% to 7% by making many of these same poor choices. DIY can be good. DIY can also be very, very bad.

 


Managing Investment Costs is Key

 

My rank order is essentially a list of the least costly (to your portfolio) to the most costly. To be fair, options 1 and 2 require the investor to have gained a working knowledge of investing and other matters related to personal finance. To come out ahead, you need to be have a sound plan, and be willing to stick to it through thick and thin.  It’s not brain surgery, but gaining that knowledge takes requires some level of interest and a fair amount of time.

Option 3 can become costly, particularly as your assets grow, but it can also save someone a lot of time and prevent a busy professional from making bad choices (see options 4 and 5). I point out the fact that it can be expensive, but there are professionals who manage sizable portfolios for a lower fee. Even a 1% fee that prevents you from trailing the indexes by 4% to 7% is an excellent investment. NAPFA is a resource to find a fee-only advisor.

Option 4 sounds like a really bad idea when I describe it this way, and it’s how many truly oblivious investors (but not The Oblivious Investor Mike Piper) have their money managed. The storefronts are everywhere and the people inside the store are gregarious. All the best salesman are. They may be good people, but if their luxurious vacations and new F-150s are being financed by their fees, which come from your pocket, how can they truly have your best interest in mind? A conflict of interest gets in the way of sound financial principles.  Your incentives are misaligned.

Option 5 is truly the worst and is frighteningly common as well. The White Coat Investor posted a list of the worst financial mistakes by physicians. It is long and frightful. Learn from their mistakes. Don’t make them.

 


You’re still not using Personal Capital? Track all your accounts in one place like I do.


 

What do you? 1, 2, 3, 4, 5, or some combination thereof?  I have a little experience with #4 from my first IRA, but I now do #1 exclusively. There are times where it has cost me more than it saved, but I consider my errors to be tuition paid toward an education in personal finance that continues to pay dividends. Let us know how you prefer to manage your money in the comments below.

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12 comments

  • DIY (#1). I do a fair amount of reading, but have not read a complete book. I do enjoy trying to beat index funds but also recognize I just may not be that good. So about 50% of my stock allocation is in ETFs and the other half is in shares of individual companies that I find valuable. :O)

    I also value return of principal quite highly so do have a fairly conservative approx 60% stocks/40% fixed income split but am feeling a bit more comfortable with my ability to ignore noise and through new contributions may let this go to a 70/30.

    cd :O)

    • There is enough quality information on the internet, if you look in the right places, that you could do just fine without actually reading a book. I do like the organized and more complete approach of a book as compared to relying solely on the web, where the information is more scattered and sometimes conflicting.

      There are lots of experts trying to beat the index, and most don’t, but if you’re among the lucky / talented quartile, more power to you. I’m happy taking the returns that the index funds give me, but I can see the allure in wanting to best them.

  • Drsan1

    I started out with number 4, after turning down many “advisors” we went with a nice guy from our church! Big mistake he was with NWM then transitioned to Guardian and wanted us to “start a new” whole life policy with the new company. Now 3 years and probably a $25-30K loss altogether. We do DIY #1 and 2 with Vanguard advisory. I have read at least 3 financial books and joined 3 blogs ( including this one). That conflict of interest it real, even in a person of “integrity”. By the way I cancelled the whole life policy as soon as I got other insurance and told both companies…No Thank You!

    • #4 is a popular choice, so you’ve got lots of company. You are probably in the minority by having looked behind the curtain, past the firm handshake, and realized that your money could be put to better use elsewhere. #4 still beats #5 though. Having read several books, this blog and others, I would guess you’ll be pretty good at DIY investing.

      There’s an interesting argument for #4’s high (and often hidden) fees being made by the big firms as our leaders threaten to apply the fiduciary responsibility across the board, replacing the nebulous “suitability” standard. The argument goes that without the fees, an advisor couldn’t make enough money off the middle class clients, and the middle class would lose access to financial advice. I guess that’s one way to justify questionable business practices, but I’m not buying it.

  • love this, you are incredibly witty! haha comes full circle with DIY, best and worst

    • Thanks, DWM! It’s funny, but I wouldn’t say it if it wasn’t based on fact. Bad DIY money management can be catastrophic. Worse than a no-good, loaded funds selling, frequent churning insurance salesman. Sad, but true.

  • We are DIY all the way. We tried, early in our marriage, to go with Option #4, but luckily for us our assets were too few at that point to warrant even a call back from the financial advisor. But around that time we wised up and realized nobody cared about our money as much as we do, so it’s been DIY from there on out. And worked quite well. 🙂

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  • Eric

    My 2 cents: I’m going to have to disagree with the order. In my experience, the DIY investor is not as successful as they could be, for a few reasons:

    a) DIY investors have a hard time “staying the course” with their investments. Vanguard founder John Bogle found that the average investor underperformed their funds by 2.2% PER YEAR from 1997-2011 due to buying/selling at the wrong time. Most people don’t like to admit to this, or even know it’s a problem. Behavioral psychologists have found that “blind spot bias” is widespread. Even if we look at the Vanguard Lifestrategy Funds – theoretically owned by knowledgeable investors who get diversification and low fees – we still find a -0.9% per year “behavior gap” between fund returns and what investors earned over the last 15 years (source: Morningstar). An advisor who works with you on an ongoing basis to keep you well informed and disciplined can help you eliminate this 1-2% per year cost.

    b) DIY investor portfolios aren’t as well diversified as they should be. Consider the last 20 years – a globally-diversified, small/value tilted allocation outperformed a traditional Total Stock Market Index approach by over 2% per year and sailed through the “Lost Decade” when the US market had a 10-year cumulative loss. This link shows the data, and also illustrates how a 60/40 mix that includes short-term bonds still outperformed the all-stock Total Stock Market Index portfolio with about 40% less volatility: http://bit.ly/2h2g6vi

    If investors can find the right advisor*, they will probably come out ahead of all the other approaches net of all fees. Robo-advisor portfolios don’t adequately diversify across small/value stocks globally, which costs more than small fee differences. And there is no ongoing guidance/advice except tweets and “retake the survey”. Hourly/fixed fee advice isn’t sufficient to keep an investor disciplined during turbulent markets, and their investment recommendations are often watered down to deal with the reality of infrequent ongoing advice/counseling.

    *I’ll be the first to admit finding a good advisor is hard. Make sure they are a Registered Investment Advisor (RIA), fee-only, don’t use market timing or active management, and use Vanguard and DFA mutual funds when managing portfolios. Finally, ask to see a copy of their personal portfolio to ensure they eat their own cooking. If only 1 in 10 advisors is worth their fee, this simple list of qualifications will likely produce 8 in 10 good ones.

    • You make some excellent points, Eric, which is why DIY is also ranked last. If done right, it can be the least expensive and quite effective.

      When done poorly, you’d be better off with a commissioned salesmen. The articles I linked to report a 4% to 7% underperformance by investors in a fund compared to the fund itself for the reasons you mentioned (buying high,selling low).

      Best,
      -PoF

      • Eric

        A few steps can help the DIY investor:

        (1) avoid all active management – even the low-cost variety. Almost every manager endures a slump, and you’re simply not able to tell the difference between a “rough patch” and a track record that was just luck. What’s more, it is often very difficult to understand the risks that active managers take, and how they change over time. For example – Vanguard Wellington and Wellesley Income Funds take on a lot of interest rate and credit risk with their bond sleeve – the very risks retirees (who these funds are most popular with) should avoid.

        (2) understand how your asset allocation (stock/bond) has performed historically during bear markets. Not just 2008, but 2000-2002, 1973-1974, 1937, and 1929-1932. Knowing how much your portfolio lost is a helpful guide for what you will have to put up with to achieve long-term success

        (3) try to diversify across primary markets – not just stocks and bonds, but US and foreign. Include some small and value stocks as well as large cap and growth. To complement US and International Total Market Indexes, consider US Small Value and World ex US Small Cap. But also respect the “tracking error” that comes along with “tilting” to small/value stocks. Higher returns and added diversification are a benefit, but not a free lunch.

        (4) don’t take too much risk in bonds. Something in the higher quality, short/intermediate maturity realm is your best bet. You’ll leave returns on the table in good times, but you’ll be glad you were conservative in bear markets.

        (5) avoid all “alternatives,” sector funds, and anything else that you can’t explain in a few seconds.

        (6) when in doubt, just stick with what you have.

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