Question from a Reader – Rollover Portfolio to Advisor?

I recieved the following email this morning from an AFM reader:


I am 32 yrs old, married with one child. I am starting a new job and need to rollover my 401k. I currently have 160k in the account and have worked with a financial planner for a couple years. Can you please review his suggestions (I’m concerned about the fees of the funds). Thank you for your time.

Large Cap Value
Van Kampen Equity & Income Fund – $14,000
Lord Abbett Affiliated Fund – $8,000
Davis New York Venture Fund – $18,000
MFS Value Fund – $18,000

Large Cap Growth
Fidelity Advisor New Insights Fund – $20,000
Hartford Capital Appreciation Fund – $20,000

All Cap
Fidelity Advisor Leveraged Company Stock Fund – $10,000

Mid Cap
Fidelity Advisor Value Fund – $8,000
Fidelity Advisor Mid Cap II Fund – $8,000

First Eagle Global Fund – $10,000
Franklin Templeton Mutual Discovery Fund – $18,000
Fidelity Advisor Diversified International Fund – $9,000

After a follow-up email with this reader, I found out that his advisor uses the “C” share class. A “C” share does not charge a front load but charges a 1% annual fee (called a 12b-1 fee) to compensate the advisor. This class also typically charges a redemption fee if the shares are sold in the first year (sometimes longer).

Though “C” shares are more expensive to own over the long-term, I like them better than “A” and “B” shares because they at least put the advisor and the investor on the same side of the table.

My Thoughts

I put together a table to show the fees associated with each fund and the total portfolio. Here is what I found out:

Based on my findings, this portfolio would cost 1.80% each year of which 1% would go to compensate the advisor (the advisor would then have to split his take with the firm). So, based on a portfolio of $160,000 the annual expense would be around $2,880 ($160,000 × .018 = $2,880). Of that $2,880, the advisor would get $1,600. As the portfolio grows, the advisor’s take would grow. The more the investor makes, the more the advisor makes. I’m all for that. The only problem I have with this particular set-up is that the amount paid as a percentage NEVER decreases. Under most other assets-under-management programs, the fees are on a sliding scale and as the account value grows and crosses different thresholds, the fee percentage decreases. So although this broker’s take is $1,600 in the first year, if the account grew to $1,000,000, his take would be $10,000.

The one thing that stuck out to me when I looked at this portfolio was the number of funds. There’s 12 funds in this portfolio. Is that necessary? I have no idea. Sometimes I wonder if advisors recommend so many funds to make it look like they are doing some work. With so many funds one would think that this portfolio represented the entire market.


The entire market?

Here’s an idea: Why not just buy the entire market?

Just for kicks, I took this guy’s portfolio and put it in two mutual funds using the same allocation between domestic and international:

The fees for this portfolio are ONE-TENTH of the fees for the advisor portfolio! Granted, there’s not an advisor fee for this portfolio since Vanguard is a do-it-yourself type of firm. So this guy would have to decide if his advisor is worth $1,600 per year. Over this guy’s lifetime, the difference in fees between the Vanguard portfolio and the advisor portfolio is unbelievable. Take a look at the following graphic to see what I mean:

Assuming that both portfolios make the same 10% return before fees, the Vanguard portfolio would be worth nearly $1 million more than the advisor portfolio in 30 years. That’s a big difference!

This reader has to ask himself these million dollar questions:

1. Is my advisor worth $1 million over my lifetime?
2. What will I get for my million dollars?
3. Will I get what I pay for?

31 thoughts on “Question from a Reader – Rollover Portfolio to Advisor?”

  1. Actually, charging a % of assets under management gives the advisor a conflict of interest.

    For example:
    What if the best choice for an investor is to have the money not held by the advisor (for whatever reason)? Surely he would never suggest such a thing.

    It encourages riskier investment. Why shouldn’t the advisor suggest you to invest 100% equities (and in risky equities at that)? They have higher expected return, so he will make more money. But perhaps that’s not the best idea for the individual investor.

  2. Hi JLP. Interesting analysis.

    Not only could you replicate the advisor portfolio with low-cost index funds in terms of asset allocation and diversification, but you could also own many of those same advisor funds on a no-load basis if you really thought they were superior. I know that to be the case with the Fidelity funds but I’m not sure about the other fund families.

    I don’t agree with your statement about C shares putting the advisor and investor on the same side of the table. I can see where that is true in certain instances when compared to A and B shares, but C shares also come with unique conflicts of interest as Andy points out in his comment.

    Finally, let’s not forget that an investment adviser needs to be paid. No one works for free in any business. A good investment adviser can provide tremendous financial benefits over time, especially for those who lack the time/interest/capacity to handle their bigger financial issues. The question then becomes what is the best way to compensate an adviser for their time and expertise while minimizing or eliminating potential conflicts of interest. My conclusion has been that the hourly or flat fee model serves clients best and appropriately compensates advisers for the many good things they do.

    Even so, everyone entering into a relationship with an adviser should give careful consideration to the long-term costs of that relationship — no matter how the adviser gets paid.

    Keep up the great work!

  3. That 1.8% is a sin. The chance the advisor can ‘beat’ the market by such a sum is near zero. This goes back to the debate between indexing and active management.
    Your suggested mix or a simple mix of S&P, foreign, and bonds would beat the return of the mix with the 1.8% drag on it. Think on this – in retirement we advise a 4% annual starting withdrawal. That 1.8% is 45% of the suggested withdrawals!

  4. Steve,

    By saying that a C-Share would put the advisor on the same side of the table as the investor, I meant OF the A,B, and C share classes, I liked the C-Share the best (even though it is more expensive in the long run). At least with the C-Share the advisor has some incentive to service the account. With an A-Share that incentive is gone as soon as the commission check is in.

  5. Instead of Vanguard, he could go with Fidelity Investments:

    $124,000 Fidelity Total Market Index Fund – Fidelity Advantage Class. Expense Ratio 0.07%

    $37,00 Fidelity Spartan International Index Fund – Investor Class. Expense Ratio 0.20%.

    Total expense ratio for portfolio is a little bit less than 0.10%, just a bit above half of Vanguard’s.

  6. In general, I agree with your receommendation: you can do tons better than what the advisor is pointing out. It’s almost like the vast number of funds is meant to comfuse the investor; everything could be done with just two funds!

  7. Ryan,

    I do think that the advisor is complicating things. I almost thing he’s doing it to “prove” his worth. Like he’s worried that a client will get a proposal with two funds and will think, “Why am I paying you so much?”

    Keep in mind that it isn’t in the broker’s best interest to have clients that aren’t confused.

  8. Such a combination of funds not only will mimic the market, but will also include extra cash drag. I bet the advisor said this portfolio will give you close to market upside but with less risk. Lets rephrase that. You can pay more to underperform the markets and to use cash to lower volatility. No thanks.

    For starters, the “advisor” that made this recommendation is a broker. He represents the interests of a brokerage firm that represents the interests of those mutual fund companies. Their interests conflict with yours.

    Secondly, many of those funds have identical no-load, no distribution fee versions that you can buy. The advisor will tell you that “no-load funds don’t come with advice.” That’s actually a good thing when the “advice” is to pay buy expensive funds.

    So, I can’t agree that the advisor is on the same side of the table.

  9. wow. awesome. no brainer to go with no load total stock market index fund – and, can’t go wrong with a small percentage (i’d do 12%, not 22%) in an intl or emerging market no load indexer. check if new employment will accept 401k transfer from old company. fire this financial planner, uh, like yesterday.

  10. One question JLP: My suspicion is that the dollar is near a long-term minimum and will start going up for awhile (and futures markets seem to indicate this too). What is the best way to go into an international fund when it may well be at a max at the moment? (I don’t have enough in int’l funds and want to move some of my money in, but I’d prefer to avoid going all-in at a market top…)

    The reason I ask is that int’l fund is strongly correlated with the dollar chart vs the euro for the past several years.

  11. A crucial point about the differing classes of mutual-fund shares is that the best choice may depend heavily on how long you plan to hold the shares.

    Generally, A shares charge a front-end load (commission to buy), B shares charge a back-end (commission to sell), and C shares charge no load but have higher ongoing expenses. Many B shares, however, will reduce and/or waive the back-end load if you hold your shares for a specified period of time (typically about 5 years). If you’re some years off from retirement and can leave the funds alone for 5 years (and you should think twice about investing in stock funds if you can’t), then purchasing B shares can give you the best of both worlds.

  12. There is one thing that perhaps some of you leaving comments have not considered in this example. That is, you assume the person who wrote the question to JLP is perfectly capable of or even interested in coming up with their own alternative to the adviser’s recommendations — such as the 2 index fund portfolio JLP put forth.

    It’s easy for us personal finance junkies to make such an assumption because we think the whole world is as interested in this stuff as we are. The fact is, there are hordes of people out there who have no clue or interest in learning about all the nuances of investing, including simple, low-cost index strategies. They are perfectly happy to rely on a so-called “expert” to help them along.

    To such investors, the concept of A, B, C shares, etc. is a foreign language. Many don’t even know what “no-load” means or that you can even buy such investments directly from a mutual fund company instead of going through a broker. Furthermore, the idea of building a diversified portfolio, even with 2 or 3 index funds, is a scary prospect to them. They glaze over when the subject turns to concepts like asset allocation, diversification, etc.

    It’s not that such persons aren’t smart enough to learn, but rather they choose not to invest their time and mental energy in the process. Nothing wrong with that. We all can’t be savvy in every area of life.

    So out into the shark tank of the financial services industry go such persons every day looking for help — just like the person who sent this question to JLP.

    I’m just curious. If you were such a person looking for professional help and knowing that you need to pay for advice (remember, no one works for free), then…

    What do you think would be appropriate compensation to pay an adviser to provide portfolio advice? Assume the adviser has the utmost integrity and fully works in your best interest and makes stellar recommendations (index funds or otherwise). What is that worth to you and how would you prefer to pay for those services (loads, asset management fees, hourly rates, flat fees, etc.)?

  13. Muddlehead — I have found that nearly all employer plans (401k, etc.) are faulty to some degree with high fees, limited investment choices, and/or very poor performing investments. Rarely does it make sense to take an old employer’s plan and roll it into a new employer’s plan. You are usually much better off going to an IRA.

  14. 1.8% is egregious, especially if he isn’t getting any other advice (retirement, estate planning, tax, etc.).

    He could hire an hourly fee-only planner to allocate assets and save a bundle. Usually, these advisors recommend instruments similar to Vanguard. In interest of disclosure, I am a fee-only planner who does hourly.

    As far as international exposure, you need to have around 30% of your equity portfolio allocated to international. You will never time the market so don’t worry about buying at the top. The long term diversification benefits outweigh timing the markets.

  15. @Steve Braun…good point, but the person was interested enough to find this blog. The book stores are loaded with financial advice books like Bogle’s books and others. The library is too. And the internet is full of web sites with free advice, as this person discovered. In this day and age, it’s too easy to do research on ANY subject…it’s hard for me to think of an excuse.

  16. @Steve Braun – JLP has showed his reader that his decision to go with the broker could make him broker by $962,000 in 30 years. That’s an average of $32,000 per year. It seems ludicrous to me that someone wouldn’t be willing to learn a little bit about investing to save himself $32,000 per year.

  17. As usual there are some really good responses to this post.


    The sad fact is that MOST people don’t understand how their broker gets paid and would be surprised to learn that they could pay a broker nearly $1 million over a lifetime.


    If a person is smart enough to be on personal finance blogs, reading about investing, then they are smart enough NOT to invest in either A, B, or C shares and invest in no-loads.

    Steve Braun,

    Regarding compensation: That’s an excellent question that is going to get a post all its own.


    I’m gonna have to think about that one. If you’re worried about the dollar, you could always DCA into international until you’re at your desired allocation.

  18. I just discovered this blog today via Money mag. These comments couldn’t be more relevant to me.

    Late in 2006, after realizing my large investment portfolio was all over the map, I hired an independent financial planner so that I could get the whole picture of my holdings on one page and hopefully get advice (and action) on reducing tax exposure. He gets paid a percentage of my portfolio. Over 5 months he gradually liquidated and consolidated all my accounts, except my 401(K)–which he never really asked or advised me about. After sitting on the cash for a while, he bought a whole bunch of mutual funds on two different days last April.

    In anticipation of my first full-year meeting with him this week, about a month ago I took a really close look at what had gone on with my money. By using the free Morningstar analyzer, I learned that my husband and I now own 42 different funds (including the 5 in my 401(K)). A couple are B shares (why?); some are only 3 star; expense ratios range from 1.36 to .43; only 7% is in foreign and that’s thanks to my 401(K).

    But the real revelation was how much I had been charged by the planner in 2007 (in addition to hundreds of dollars in transaction fees). Assuming a high hourly rate, he would have had to spend 60 hours of his time this past year on my account to come even close to justifying that fee. We met once in September for an hour (where I pointed out that his fee was supposed to be 1% not 1.25% based on my portfolio size) and I emailed him a couple questions over the year–did he spend 58 other hours on my account?

    I don’t hold him too accountable for the losses in my accounts–that’s the market–but after all my years holding no load accounts with no fees at a discount brokerage this guy’s fee is not sitting well with me. I was planning to see what he had to say this week (how he explains the value of his services, what he did for tax sheltering since my taxes were huge this year), but since, as JLP put it, I’m smart enough to be on personal finance blogs, read about investing, know not to buy load funds, believe in dollar cost averaging, etc, I’m realizing I’ll probably be firing the guy this week. Gulp. Wish me luck.

  19. A couple of comments:
    Is the advisor’s suggestion really the whole market, I don’t see small caps (which is bad IMHO).

    I think the advisers fees are absolutely horrible, but creating a number like 1 million without talking about inflation is one of my pet peeves. Unless of course you think you can get a 10% real return, in which case I like your optimism.

    Instead of asking how much a financial planner should be paid, lets ask how long it should take to do his job. If its a couple of hours every couple of years, then an hourly fee makes the most sense. I don’t see why planning for a typical investor should take much more than that.

  20. @JLP: For at least some of the fund families I reviewed for my own IRA, the C shares *were* the no-load shares. However, in exchange for not having a load, they have a higher expense ratio. While I would always recommend against A shares (front-end load), if the fund’s fees are set up so that back-end loads are waived if you hold for a certain period of time, you’d be better off going with the lower expense ratio and still not having to ever pay the load.

  21. Christopher,

    C shares are load shares. Why? Because if they were truly no-load shares, they would not have increased management expenses to make up for the difference. I realize that advisors need to get paid for their services, but let’s be realistic: C shares ARE load funds.

  22. @Francise Rose…I’m not trying to make excuses for this person or others. All I’m pointing out is that there are lots of people who do not want to take the time or energy to look into these issues. Or, they aren’t confident that they can decide what is best for themselves. The jargon alone scares a lot of people away from learning more. Sure the resources are out there, but not everyone wants to dive in.

    Take me. I’m bright enough to learn about my computer and handle all of the software and hardware issues that come up for my business — if I want to invest the time and energy to learn. But I don’t want to. Plus I find computers boring. I’d much rather pay my “computer guy” to keep up with all that stuff while I do more fun things with my business and life. Lots of people take that exact same approach with their finances and investments.

    @Dave…You make my point exactly. It seems logical to you or me (personal finance junkies hanging around blogs on a Sunday) that someone would want to spend the time learning for that kind of money. In hindsight it’s a no-brainer. The general population, however, is virtually clueless about investment fee structures and the real costs. In addition, most people lack the skills or knowledge to decipher those investment fee structures in order to do the math to determine the real cost of a particular portfolio over time.

  23. I usually enjoy your blog, but I think both you and your readers really missed the ball on this one! As a CFP, myself, you need to account for a lot more aspects than just fees when evaluating portfolios.

    Take a look at the recommended Davis New York Venture fund, for example. The fund outperformed the Vanguard Total Market index by an average annualized return of 1.57% over the last 5 years, 2.27% over the last 10 years, and 1.87% over the last 15 years. When you also take into consideration that this fund only has a beta of .86 (14% less risky than the S&P 500), I think the client is still in a far better situation if he/she goes with the advisor. Not only is he exposing himself to less risk, but he is outperforming the S&P 500. By judging a fund, or a total portfolio for that matter, only by the fees is foolish.

    Now, look at First Eagle Global’s numbers. The fund outperformed the Vanguard Total Market index by an average annualized return of 7.77% over the last 5 years, 9.77% over the last 10 years, and 4.13% over the last 15 years! Are you still going to complain about the fees with those numbers??

    If you can find an advisor who filters for only the BEST risk-adjusted funds at a reasonable cost, most times the client would be far better off going with an advisor than if they simply socked the money away in the lowest-cost funds they can find.

    And no, I do not think 12 funds is excessive in a well-diversified portfolio (over $150-2000k) if they are properly selected from different categories (lg caps, small caps, international, emerging markets, inflation adjusted bonds, hi yield bonds, alternatives, etc). Lowering your correlation to the markets is invaluable, as is lowering your overall portfolio risk levels.

    Also, all clients do not have the same risk tolerances, so why should portfolios? Funds allow the advisor to better cater this risk by diversifying the risk or buying funds with lower risk levels.

    Yes, 70% of all mutual funds “underperform.” But a fund that returns 9% (when the market returns 11%) with 50% less risk than the market is not a bad fund like those commercials make it seem! So really, we are talking about 40-60% of mutual funds being very much worthwhile for clients – all things considered.

    I hope you give these other considerations more attention going forward. Thanks!

  24. @Travis — Good points you made but you’re mixing apples and oranges when comparing these mutual funds with the S&P 500 or even Vanguard Total Stock Index. First Eagle Global, for example, is nearly 40% non-U.S. stocks which have done incredibly well against the U.S. market over the past 5-7 years. Plus nearly 6% of its assets are in pure gold (its largest holding). You can’t compare that to the S&P 500 or to Vanguard Total Stock Index. Of course it outperformed — just like it would have likely underformed if the tables had been turned and U.S. stocks were hot while international and gold were not (assuming the current mix had been held in the past too).

    Just curious…Once you determine the appropriate risk tolerance for the client, isn’t the best thing then to set the proper asset allocation to match that risk tolerance? Then your benchmark for evaluation becomes the relevant hypothetical “index” for that particular asset allocation?

  25. Yes, Steve. My mistake. I meant to compare it to the other. Hard to follow when you have to keep scrolling up and down! If I had to guess though, I bet it would have outperformed just like the Davis New York Venture fund, although I’m not as familiar with this fund.

    First thing we do is determine risk tolerance. For about 8 out of 10 clients, the average up and downs of the S&P 500 are much too wild for the client’s needs/tolerances, let alone a mix of U.S indicies and international indicies!

    We then build a diversified portfolio and compare it against either the S&P 500 or a customized benchmark. That way, the clients knows exactly how much risk they are taking on and roughly what kind of performance one can expect. It’s through this process, the clients can really see the value-added of hiring the best money managers in the world to run their money. The best is when we can show a client a proposed portfolio with low correlation, less risk than the market, matches their risk tolerances, and still has a good chance at “beating the market.”

  26. Travis,

    You are correct. I did focus on fees.

    Just because a fund has outperformed an index in the past does not necessarily mean it will continue to outperform in the future. Yes, some funds do, but that wasn’t the point of my post.

    You said:

    “For about 8 out of 10 clients, the average up and downs of the S&P 500 are much too wild for the client’s needs/tolerances, let alone a mix of U.S indices and international indices!”

    Really? Do you work mostly with retirees?

  27. Just to prove my point I ran two portfolios. The 1st I used what you recommended (124k Vanguard Total Market and 37k Vanguard Total International). The 2nd I put 124k into his existing Davis New York Venture and 37k into First Eagle Global.

    Vanguard Portfolio (5 yr numbers):
    beta = 1.05
    std dev = 9.90
    average annualized return = 14.73%

    Acitively Managed Portfolio (5 yr numbers):
    beta = .73
    std dev = 7.65
    average annualized return = 18.62%

    So let’s see: by going with the mutual funds with higher fees, not only do you got an average yearly outperformance of 3.89%… but you do it with 30% less risk (beta)! And yet, 90% of the readers here sound like they would take the 1st option simply becuase of lower fees!

    Sure, past performance does not guarantee future results, but if you find the right managers who have consistently added risk-adjusted performance throughout the years, there is a good chance this will continue.

  28. Also, it should be known that A-shares do not cost the client anything if they are inside a normal fee account. All the client is charged is the 1% annual fee (or whatever the advisor sets). Additionally, like my firm, many firms REFUND 12b-1 fees back to client, so the fee expenses are actually lower than stated.

  29. Travis, way to cherry pick after the fact. If I was to pick two funds from that list of 12 to have over the past 5 years those two would be great. How about comparing the real return of the 12 holding portfolio with the proposed 2 holding portfolio and for periods of other than the last 5 years which was a bull market for stocks, int’l, and commodities.


  30. Travis,

    It strikes me that it’s very hard to consistently beat the market indices. After management costs are paid it becomes even harder since index funds have such low costs.
    While some managed funds do beat the market for a while my impression is that studies have shown that the indices win in the long term, and investments should be about the long term.
    It also seems to me that that there really isn’t any reliable way to pick the market beating funds from among the thousands of possible funds. If I can’t be sure of picking a good fund, why not pick the cheap average fund? If 70% of funds do underperform then my chance of picking a worse fund is at least 70%- likely much higher after fees.
    How would you justify picking an actively mutual fund X to a client? I can see following winning managers or past performance but neither seems to be a real guarantee. In fact it seems both would lead to buying funds at a premium.

    -Rick Francis

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