A reader asks:
I recently started looking at my mother-in-law’s retirement account. she has been with [advisor name redacted] Since October 2010 and has an annual return of 2.61%. According to their chart, the S&P 500 had an annualized return of 12.95% during the same period. While I know he shouldn’t expect returns on par with the S&P 500 since he’s not all in equities (he’s in 60% stocks, 40% bonds), it’s disappointing how much he’s underperformed.
he has a new advisor [name redacted] He is in a few mutual funds and has 60% of his equity exposure in seven stocks, which he changes two to four times a year. I talked to him and he insists on holding seven stocks to “juice” his returns.
Should I cut her losses and move her IRA to an account where she can be in the Target Date Fund or the Bogle Three-Fund Portfolio? Is there something I’m missing or is there a reason she should stay with her current advisor? Am I crazy to think that 60% of your equity exposure in seven stocks is too risky for most people?
It is generally wise investment behavior to ignore short-term performance as long-term returns are what matter. But at some point you have to benchmark your performance in some way.
Many years ago I had a neighbor who was always in his garden. My wife and I would watch this guy work for hours and hours, but we could never figure out exactly what he was doing because his landscape still looked like crap.
Lots of weeds in the wet grass. Areas of patchy grass. High flower beds.
There’s nothing wrong with being in the garden all the time if you enjoy being outside, but it would be nice if his being there actually yielded some results.
It sounds to me like your mother-in-law’s financial advisor is a lot like my old neighbor. Certainly, they are doing something in the portfolio but are not able to give much results for its performance.
If we wanted to take this analogy a step further, I’d say he’s also growing a lot of weeds.
My biggest concern beyond the performance numbers is the concentration risk they are putting him through.
There are two types of risks when investing:
necessary risk That’s the uncertainty you face when putting your capital to work in the financial markets. You have to invest your money in something if you want it to grow over time.
unnecessary risk That is the risk that is specific to your chosen investment strategy or behavior.
Keeping the majority of your stock market exposure in just 7 stocks is a form of unnecessary risk because it is so easy to diversify your portfolio these days. The range of results increases exponentially when you have a minimum amount of stock.
Sure, a concentrated portfolio gives you the opportunity to outperform but it also substantially increases your chances of underperforming, which is probably what is happening here.
The idea of trying to “juice” your returns to compensate for past losses is a recipe for disaster. Mistakes like this can compound the market. Doubling down after a period of poor performance does not guarantee you anything other than more risk.
Ben’s rule number one for financial advisors do no harm. This consultant is not following this rule.
Let’s look at a simple Vanguard three fund portfolio1 to see how poorly its portfolio has performed. Here are the results from October 2010:
So we’re looking at 6.1% per year versus 2.6% per year.
Let’s say your mother-in-law had a $500k portfolio in October 2010. Their 2.6% annual return would have increased this to about $740k.
Had she been in a simple Vanguard portfolio, it would have been more than $1.1 million.
I am not saying that a three fund portfolio is the only answer here. This is a good start as a benchmark, but I would also ask your mother-in-law if she is getting something else out of the relationship.
If his advisor is only helping him with investment management, not only are they doing a poor job, there are other ways they could be adding value.
There is a lot more involved in becoming an advisor beyond portfolio management – financial planning, tax planning, insurance planning, estate planning, withdrawal strategies, budgeting and helping people make more informed financial decisions.
If they are simply investing his money and doing so by picking 7 stocks that is not a financial advisor – it is a stockbroker (and not a very good one).
So it’s probably not as simple as putting it in a Vanguard portfolio and calling it a day. He needs help understanding what is going on with his investment plan, right or wrong.
You also have to be careful how you approach this conversation.
This was a costly mistake. People don’t like to talk about financial mistakes, which is one reason there can be so much inertia when it comes to making this kind of change.
There’s also a good chance that your mother-in-law didn’t even realize how bad things were because the consultant has probably been making excuses along the way.
Don’t make him feel bad about what happened here. Help him learn from his mistakes. Work with him to find someone who can help right the ship, diversify his portfolio, and manage risk more prudently.
I would suggest you find him someone who can help him create a comprehensive financial plan, set realistic expectations up front and be more transparent about how they are managing money.
It makes perfect sense to outsource your portfolio management but you can’t outsource your understanding of what’s going on with your money.
We discussed this question in the latest edition of Ask the Compound:
We also covered questions about buying a vacation home, using CDs instead of bonds, financial struggles with kids, and gambling on sports.
7 Simple Things Most Investors Don’t Do
1Total US stock index funds (35%), total international stock index funds (25%) and total bond index funds (40%).