Readers ask:
I recently started looking into my mother-in-law’s retirement accounts.she was with me [advisor name redacted] Since October 2010, the annualized return is 2.61%. According to their chart, the S&P 500’s annual return over the same period was 12.95%. I know she shouldn’t expect returns on par with the S&P 500 since she’s not all invested in stocks (60% stocks, 40% bonds), but how poor is her performance? It’s frustrating.
she has a new advisor [name redacted] She invests in several mutual funds and has 60% of her equity exposure in seven stocks, which she changes two to four times a year. I have talked to him and he is adamant about keeping her 7 shares to “leverage” her profits.
Should I cut her losses and move her IRA to a target date fund or an account that can go into Bogle’s 3-fund portfolio? Is there a reason to stay together? Am I crazy to think investing 60% of your stock exposure in 7 stocks is too risky for most people?
It is generally a wise investment move to ignore short-term performance, as only long-term returns matter. But at some point you need to benchmark performance somehow.
A few years ago, I had a neighbor who was always out in the garden. His wife and I watched this guy work outside for hours and it was hard to understand exactly what he was doing because his landscaping still looked like crap. could not.
There are a lot of weeds growing inside the mulch. Area of spotted grass. An overgrown flower bed.
If you like being outside, there’s nothing wrong with being in your garden all the time, but it would have been nice if the time spent outside actually had some results.
Your mother-in-law’s financial advisor sounds a lot like my old neighbor. True, they are working on the portfolio, but they have not brought significant results to her performance.
To take this analogy a step further, you could say that he also grows a lot of weeds.
My biggest concern here, more than the performance numbers, is the concentration risk she takes.
There are two types of investment risks:
necessary risk It is the uncertainty that arises when investing capital in financial markets. If you want it to grow over time, you need to invest money in something.
unnecessary risk Risks specific to a chosen investment strategy or action.
It’s so easy to diversify your portfolio these days that holding the majority of your stock market exposure in just seven stocks is a form of unnecessary risk. As you hold fewer stocks, the range of outcomes increases exponentially.
Certainly, a concentrated portfolio gives you the opportunity to outperform, but it greatly increases the chance of underperformance. This is probably what’s happening here.
The idea of ”squeezing” profits to make up for past losses is a recipe for disaster. In this way, mistakes can become even worse in the market. Doubling down after a period of underperformance guarantees nothing other than increasing risk.
Ben’s number one rule for financial advisors is: Do no harm. This advisor does not follow this rule.
Take a look at a simple Vanguard 3 fund portfolio1 To see how much her portfolio is underperforming. Results since October 2010 are as follows:
So compare 6.1% per year to 2.6% per year.
Let’s say your mother-in-law had a $500,000 portfolio in October 2010. If her annual return was her 2.6%, that portfolio would grow to about $740,000.
Had she been in a simple Vanguard portfolio, that number would have ballooned to about $1.1 million.
Wow.
I’m not saying a three-fund portfolio is the only answer. This is a good starting point as a benchmark, but I’d also like to ask your mother-in-law if she can get anything else out of this relationship.
If her advisor is only helping with investment management, not only is she not doing her job well, there must be other ways she can add value.
Becoming an advisor involves much more than portfolio management, including financial planning, tax planning, insurance planning, estate planning, withdrawal strategies, budgeting, and helping people make more informed financial decisions. I need a job.
If they’re simply investing her money and doing so by picking 7 stocks, it’s a stockbroker, not a financial advisor (and not very good stocks).
So it won’t be as simple as adding her to Vanguard’s portfolio and calling it a day. She needs help understanding what is going on with her investment plan, rightly or wrongly.
You should also be careful how you approach this conversation.
This was an expensive mistake. People don’t like to talk about financial failure. This is one reason why there is so much inertia when making such changes.
There’s also a good chance your mother-in-law didn’t even know how bad things were, as your advisor likely made excuses along the way.
Don’t make her uncomfortable with what happened here. Please help her learn from her mistakes. Find someone who can work with her to right the course of her ship, diversify her portfolio, and manage risk in a more prudent way.
We recommend that you help her find someone who can help her create a comprehensive financial plan, set realistic expectations upfront, and be more transparent about how she manages her money.
While it makes perfect sense to outsource your portfolio management, you can’t outsource your understanding of what’s happening to 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 difficulties with children, and sports gambling.
References:
7 simple things most investors don’t do
1Total U.S. equity index funds (35%), total international equity index funds (25%), and total bond index funds (40%).
