Why Do Financial Advisors Do Crap Like This?

Here’s a scenario that’s played itself out several times since I started writing about personal finance. A couple, at or around retirement age, whose finances have been managed by various “professionals” in the financial services industry, would like some help making sense of their investment portfolio.

I’d like some help, too. You simply cannot make sense of these ridiculous portfolios. Why do financial advisors compile these steaming piles of crappy funds and call the heap an investment portfolio? I’m not entirely sure, but I’ve got some ideas.

Fiduciary Schmiduciary

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Years ago, I dissected the portfolio of a recently retired couple. They were in a portfolio of roughly 60% stocks and 40% bonds with a 3:1 ratio of U.S. stocks to international stocks. An asset allocation like that can easily be achieved with a three-fund portfolio of very low-cost index funds that guarantee you’ll capture the market returns, thereby doing better than the vast majority of those who try to beat the market.

Study after study shows that it’s really tough to outperform index funds over the long-term after accounting for fees. Those that manage to beat the market usually do so by taking on more risk (via leverage or other means) or get lucky with the equivalent of 10 consecutive heads in a coin-flipping contest.

Back to that couple’s 60% / 40% portfolio. It’s now in a three fund portfolio, or the closest thing we could get to one without realizing capital gains unnecessarily, but before that, they had 28 funds (26 mutual funds and 2 ETFs). Six of those funds had expense ratios of over 100 basis points (1%), whereas most index funds are in the 0 to 10 basis point range. The average expense ratio of the funds this couple owned was 0.67%.

They were also paying 0.73% of assets under management for the privilege of this messy, poorly-designed portfolio that was clearly underperforming a benchmark 60% / 40% portfolio of index funds. Trust me; I checked.

Between the AUM fees and expense ratios, this couple paid over $20,000 a year to have this hodgepodge of assets. There were actively-managed, tax-inefficient funds in the taxable brokerage account. No tax loss harvesting had ever been done. Who was benefitting from these counterproductive investment choices? Not the client. That leaves one party.

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