At Keen Wealth Advisors, once we’ve created a financial plan for a client, we next work to determine the proper ratio between stocks, bonds, and emergency reserves they need to make that plan work. Our strategy of portfolio diversification, quantitative stock analysis, periodic adjustments, and short-term cash buckets for income needs is designed to help generate wealth for a family over decades, not days.
We believe it’s best to keep things efficient, so we try to recommend that clients reduce unnecessary complexity and costs in their long-term money. We generally use individual securities (stocks and bonds) along with “indexes” that are designed to follow preset rules so the investment can track a specified basket of underlying holdings. By utilizing individual securities and indexes, we can help control tax implications and be proactive on the timing of taking gains and losses.
In our opinion, we typically believe it’s smarter to have a globally diversified portfolio than to invest solely in the US market. And in most cases, we discourage our clients from using mutual funds for three important reasons.
1. Mutual funds can be expensive.
When you sit down with a financial advisor to discuss investing in a mutual fund, always ask them for the total cost of the plan they’re putting together, including their own advisor fees. Often, either they will tell you a half-truth, or they simply don’t know. That’s because a good many mutual funds tend to be significantly more expensive than people realize.
If you own a mutual fund, you will pay fees inside the fund, as well as transaction costs. Some of these fees are easy to find in the prospectus, but some are buried deep in the small print. Your total cost in fees for a mutual fund can easily be over 1 or 2 percent or more of your total investment annually. (1) Your financial advisor may also charge between 1 and 1.5 percent to manage your mutual funds. Suddenly, you find that you’ve engaged in something that is consuming upwards of 3 to 4 percent of your total investment in fees alone each year. If you ask the advisor up front for the total cost, they will probably only tell you about their specific advisor fees. This kind of half-truth is fairly common in the industry.
One way to avoid these issues is to work with a fiduciary advisor rather than a broker. Fiduciaries, like my team at Keen Wealth, are legally obligated to put the clients’ best interests first. We are transparent about the total costs of having us managing your money, and do not recommend financial products to you which may have hidden costs. We don’t want you to consider our fees an expense, but rather an investment and meaningful return in your future.
2. Past performance doesn’t guarantee future returns.
When a fund has a good year, it tends to attract a lot of money, because people generally look at recent performance when deciding where to invest. Once the fund attracts a ton of money, it may become bloated and that could make it more difficult to replicate its previous performance.
We’ve also seen fund companies seeding many funds over time, then closing the funds that do poorly and keeping and promoting the ones that happen to do good. This practice can cause an investor to believe that the fund will replicate its performance when it may have just been luck or random. We see people chasing performance in mutual funds all the time, and their returns are almost always disappointing.
Now, that’s not to say we disregard recent performance when we’re managing our clients’ portfolios. When the market is down, we look for opportunities to “buy low.” When the market is up, we reevaluate our rebalancing targets and look for advantageous ways to diversify further. But the reason we’re able to do that is because the overall arc of our financial plan is aimed at the retirement that our clients want to achieve. That long-term perspective gives our plans flexibility to adjust in the short-term, whether our clients want to increase their investments or need to pull out some cash to cope with a sudden health emergency.
3. Inefficient Tax Ramifications
Consider the complexity of tracking gains and losses inside of a mutual fund where tens of thousands of participants own units of the pool. Each year the fund is required to add up all the gains and losses for each security that the fund had for the current tax year and pass those tax consequences to the unit holders proportionately. The fund may have long-term gains on holdings that it decides to sell in a given year, and the taxes on those gains will be paid by the current unit holders—even if the unit holders didn’t receive the gain! These are called inherited tax liabilities, and they should be avoided at all cost.
Imagine buying into a fund this year and potentially being down on your investment, but still receiving a tax bill for gains—gains you didn’t receive. We’ve seen this especially in volatile years like 2002 and 2009. Many unsuspecting investors in taxable accounts learn about this the hard way.
Again, one of the reasons many investors get those unpleasant April surprises is that they’re not working with a advisor who’s helping them manage the totality of their financial plan. Our process at Keen Wealth doesn’t stop once we’ve allocated your resources to a portfolio. Whether you’re preparing for Tax Day or navigating the Medicare open enrollment period, my team prides itself in providing advice you can trust and connecting you to other professionals who can help.
Do you have any questions about what’s under the hood of your financial plan? Let’s schedule some time to review your investment strategy and make sure our process and your goals are in sync.
This article was adapted from my book, Keen on Retirement: Engineering the Second Half of Your Life.
Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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