In December of last year I wrote that “You Don’t Need Someone In Charge of Your Money,” then last week I wrote about using annuities as a tool to help retirees manage money. Is last week’s post an admission that you do need professional money management?
A long-time financial services professional commented on last week’s post. He believes professional financial managers are useful, especially when people don’t want to manage their own money.
Perhaps I can summarize my view in a sentence: investors surely should hire managers if they can’t or don’t want to manage their own money, but investment managers are expensive and many people don’t need them.
Managing your own investments takes a little knowledge of high-school math. Ratios and percentages are essential, and perhaps a little algebra. A person should be able to read a graph and think a little with quantitative concepts. An investor also needs to know or learn some fundamentals about how a modern capitalist economy works, with corporations that issue stock and bonds and with governments that tax, spend and issue debt. A life-long interest in learning helps.
There are many people who don’t fit the above profile. Many Americans can’t read above an eighth-grade level, and many more have almost no working knowledge of mathematics beyond addition. Still more have little understanding of how an economy works. Such people will truly need help.
But if you don’t need the help, why pay for it when it is expensive? In a previous post, I compared passive, self-directed investing with a fairly typical example of active investing. The active investor hired a financial advisor who charged 1% and put the client’s money in average-cost mutual funds. Readers saw that retirees who instead invested passively, after 15 years from 1997 through 2011, had 55% more wealth. If we think about incurring the extra costs of active investing for 30 or 40 years of work, then another 30 or so of retirement, the superiority of the passive approach would be astounding.
I lucked into low-cost investing in 1969 when my first career-employer required employees to enroll in TIAA-CREF retirement plans. When I left that employer, I owned the accounts and took them along. I followed some early academic advice about asset allocation, and I added to those accounts over many years through payroll deductions and employer matching programs. TIAA-CREF was a nonprofit company serving educators, and its early stock funds used mostly index investing.
Since then I have added Vanguard funds. I have read studies, books, and popular articles about the merits of passive, index investing. Because I along with millions more have done it, I’m convinced that many more who are using average quality planners can benefit from taking charge of their money and investing with a simple passive approach.
A high-school friend of a friend is an independent financial advisor with no ties to any financial company like Edward Jones or Merrill Edge, and he receives no special payments from investment companies. He charges 1% per year on the first million dollars under management, then less on additional investments. He is an honest, hardworking man, and I would trust him with my money.
Yet he too uses Vanguard. Unless directed otherwise, he invests his clients’ money in Vanguard index funds. Most of his clients are still working and using him to direct and manage their retirement investments. It didn’t take me long to realize that I was doing 1% per year better than most of his clients. Over 30 years that adds up.
Driving a Car
Sometimes I think investing is like driving a car. Everyone need to learn the fundamentals: steering, gas, brake, maybe clutch, lights, etc. Everyone needs to learn the rules of the road. Some people have accidents involving serious injury or death. But most people know about the risks and therefore drive carefully. They also learn to accept the risks that remain.
Of course people consult experts on occasion—mechanics for repairs and experienced users who keep up with new models.. Most people, however, buy and drive their own cars. They don’t hire a driver to tote them around.
Alice, our model retiree, could easily be a real person. She invests in four mutual funds, plus an account for cash. She needs to figure ratios and proportions to keep her investments in balance.
Alice also has strength of character, which is not easily imitated. When markets fell sharply in 2008 her portfolio dropped over 20% in value, yet Alice didn’t panic. She cut her withdrawal from $12,000 per year to $10,000 per year, vowing to cut it more if her investments continued to fall. Through rebalancing she purchased some stock and REIT shares at low prices. That behavior is easy to describe in numbers but hard to live. Alice may well have consulted a financial adviser during the turmoil to ask for a little handholding. It would have been money well spent. Then she carried on.
As we age our abilities and interests in investing may decline, and we need to plan our approach to such problems. We should also plan for the time when we may need to stop driving. Entrusting a portfolio, or part of one, to a professional manager may be a good solution. Maybe a family member can help, maybe an annuity will work or perhaps a formal trust is appropriate. All of these have their advantages and disadvantages, and we can discuss them in the future.
But for most people during most of their lives, a self-managed portfolio of low-cost index mutual funds is as close to a sure bet as exists in the investment world. Increasingly, as private firms and governments limit or cut pensions, workers will find themselves in charge of saving and investing for their retirement. They need low-cost models to accumulate wealth for retirement. Many workers will hire financial managers, but those workers may want to know that many others, though not all, are doing better on their own.