I used to represent investors who had been victimized by broker misconduct. During arbitration proceedings, the broker would often justify his conduct (and worth) by discussing how complicated investing is, given the many different investment options.
The allure of complexity
Complexity is the lure that the securities industry uses to seduce investors. Once you are persuaded investing is complex, it’s much easier to convince you to use a broker who can “explain” everything. Greg Smith, a former Goldman Sachs employee, put it this way: “The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.”
Smith’s list of clients that his former firm deemed “unsophisticated” was chilling. It included philanthropies, endowments and teachers’ retirement funds. If these institutional investors were no match for Wall Street, how do you like your chances?
Simple is better
There’s compelling data indicating you would be better off avoiding complex, alternative investments (like private equity, venture capital, hedge funds, private real estate, infrastructure, farmland and timberland) and limiting your portfolio to publicly traded securities.
Choosing the right investments is actually very simple. But there are other aspects of investment management that do require skill, like determining the right asset allocation and measuring risk. Ironically, in my legal practice, I found few brokers who had any grasp of these subjects. That’s because the real money is in selling complex products, which typically charge high fees. You can find a sample asset allocation questionnaire on my website.
I know a financial advisor who manages hundreds of millions of dollars for very sophisticated clients. Their holdings are invested in one core fund.
Core funds are broadly diversified mutual funds in a given asset allocation between stocks and bonds. Vanguard’s Balanced Index Fund Admiral Shares (VBIAX) is an excellent example. If a suitable asset allocation for you is 60 percent stocks and 40 percent bonds, this fund could be an excellent choice. The fund tracks two indexes that represent broad barometers of the U.S. equity and U.S. taxable bond markets. It’s very broadly diversified, holding 6,525 bonds and 3,078 stocks (although it does not include international stocks).
The expense ratio of this fund is a puny 0.08 percent. For the 10-year period ending June 30, 2016, the fund’s after-tax returns were 6.92 percent, annualized. When you compare those returns to yours, remember that most mutual funds report returns pre-tax. The difference between pre-tax and post-tax returns can be significant.
If you want to customize your asset allocation and include international stocks, you can do so by purchasing just two index funds. Vanguard’s Total World Stock Index Fund Investor Shares (VTWSX) gives investors low-cost exposure to global stock markets, including the United States. Its expense ratio is 0.25 percent, which is significantly lower than the average expense ratio of funds with similar holdings.
Since its inception on June 26, 2008 (bad timing!), this fund had an after-tax return of 3.75 percent annualized.
You could pair this fund with Vanguard’s Total Bond Market Index Fund Admiral Shares (VBTLX). This fund provides broad exposure to U.S. investment-grade bonds, with short- and intermediate-term maturities. The expense ratio of this fund is only 0.06 percent. Its 10-year annualized returns, after taxes on distributions and sale of fund shares, was 3.45 percent.
If you decide to use this two-index-fund portfolio, don’t forget to rebalance once or twice a year (or when needed). For more information on rebalancing, and why it is both counterintuitive and important, see this helpful article from Morningstar.
Don’t succumb to the attraction of complicated investments. If you do, you may find much of the appreciation in your portfolio will be transferred to your broker’s pocket instead of remaining in your retirement account. By adopting simple investment strategies, your expected returns will be higher and your costs will be lower.
Dan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and the Director of Investor Advocacy for The BAM ALLIANCE. He is retained as a sales coach by advisory firms and others throughout North America.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.