Where it all startedRemember, this is a company built on the premise that professional hedge fund managers who spend their lives honing their craft are no better at gaining you a winning profit than flipping a coin. They will tell you (rightly) that you can do better by just following the market. In fact, the boglehead’s way is to simply purchase diversified low-cost index funds with good asset allocation. Set it and forget it. So, why are they pushing for advisors? Let’s dig in.
The Vanguard ArgumentIf you want to see the original research paper, then you can find it here. If you want the abbreviated, polished, and easier to read version on Vanguard’s website, that you can find here. On the website page referenced above, Vanguard points to three key features that warrant the value (i.e. the cost) of a financial advisor. In turn, they are the following:
- “Serving as your investment coach.” The essence here being that a good advisor will prevent you from making stupid financial decisions.
- “Minimizing your taxes.” They advocate two ways that an advisor can save you on taxes. First, they can determine tax-efficient ways to invest. Second, they can make sure you withdraw your money in a tax-efficient manner.
- “Building your portfolio with low-cost funds.” I don’t think I need to explain this one, but the idea is that good research shows that passively managed index funds outperform their actively managed and higher-cost counterparts.
Okay, but how much does it cost?The financial advisor service through vanguard costs 0.3%. To be fair, this is substantially less than the industry standard, which is around 1%. That said, how much will 0.3% cost you over a typical 30 year career and 30 year retirement? Let’s do the math. Here are the assumptions. $50,000 invested each year for 30 years earning 7% on average. Then taking out 4% per year for thirty years thereafter while earning 6%. During your thirty year accrual phase, you could expect to earn $4,723,039 without an advisor (earning 7%). With the advisor you would earn 6.7% which turns out to be $4,475,622. So, during your thirty year career your advisor has now cost you a total of $247,417 over thirty years or $8,247 per year on average (though really its 0 dollars the first year and around $14,000 your last year). Of course, as your nest egg continues to grow this will only cost you more each year. Assuming the number you end up with (4,723,039) grows at 5% while you take out $200,000 each year to live on, you could expect to have $7.125 million. With the 0.3% investor fee, you can expect to have $6.110 million. Or a difference of a little more than $1 million. So, the question becomes the following. Do you think that the three reasons Vanguard gives for having a financial advisor is worth $1,250,000 over sixty years? Another way to ask this is the following: Will you make $1.25 million in mistakes over the next sixty years with a set it and forget it method? Maybe. Let’s talk about it.
Three Counter-ArgumentsVanguard has laid out why they think financial advisors (or investment coaches) are helpful. We have also discussed how much their service may cost you over a typical 30 year career and 30 year retirement ($1,250,000 for the above assumptions). To be fair to Vanguard, I must mention that with the same assumptions above, if you use an advisor with the typical industree standard (1% advisor fee), this would cost you $770,130 in the accrual phase and $5,500,000 during your retirement phase. All together, that’s roughly $6.25 million dollars. There is no way any one who spends even a little bit of time can justify this cost. That said, Vanguard’s cost is much lower. Can they justify their cost? Here are the arguments and counter-arguments to each of Vanguard’s points.
Do we really need An Investment Coach?Vanguard’s first point is that you need someone to help you stick with the plan. After all, there is good research to show that if you don’t stick to the plan, there are few decisions that will be more catastrophic to your financial success. It might battle with divorce for the number 1 spot. A Random Walk Down Wall Street gives a great example of this where if someone were to invest $1 (a single dollar) into the market in 1900 it would have grown to $290 by 2013. However, if that same person missed the five best days in the market each year (but kept their money in for the other 360 days each year), that $1 would be worth less than a penny. Let that sink in. Timing the market and not “Setting and forgetting” into a good plan can be devastating. It’s incredibly important to ride the wave and stick to the plan. Otherwise, you become your own worst enemy. So, if you know yourself and you are unable to stick to a plan without a financial advisor, I have to agree with Vanguard. It’s worth every penny for that person. However, if you have the mental fortitude to pick a solid plan, set it and forget it, and only rebalance once each year (regardless of what the market is doing)… the advisor costs are probably not worth it, in my opinion.
Minimizing taxesUnfortunately, many of the taxes you will incur during retirement will have to do with how you set up your portfolio. How much standard versus Roth contributions do you have? Where are your bonds located (tax efficient retirement accounts or taxable accounts)? So on and so forth. With that in mind, it is good to have a sound plan put in place prior to getting to retirement. If you don’t feel the need to read up a little bit on this or to take a course like White Coat Investors “Fire your Financial Planner” course, then a financial advisor from Vanguard is again worth every penny. However, there are free DIY-investing resources out there to help you set and forget it in a tax-efficient manner. Here are some examples from some great websites I follow:
- POF over at Physician on Fire gives a great example at the end of this post on how to minimize tax drag in retirement.
- POF also talks about how to avoid taxes completely in retirement, too.
- You can visit a post from White Coat Investor on tax-efficient investments in taxabale accounts.
- Wall Street Physician has a word on to say on picking the right tax-efficient allocation.
Building your portfolio with low-cost fundsIf you are reading this website, I probably don’t need to talk you into using low-cost index funds. Ironically, neither should Vanguard since they are the King of low-cost index funds. They invented them. You can see why I find it strange that Vanguard is touting their financial advisor service with this as a supposed benefit. If you know about Vanguard at all, you likely don’t need an advisor to tell you to use their index funds. If you don’t know a lot about index funds and want to learn more you can read the books I referenced at the beginning of this post or you can read this from the Boglehead’s Wiki. It is chalk full of references. Oh, and if you thought that the investor fee from Vanguard costs a lot…Imagine a 1% expense ratio and management free for high-cost funds will run you over 60 years. If you are curious, you can visit the example above for the advisor with a similar 1% fee. Hint: It’s a boat load of money.
Take HomeThe take home point is this. The vanguard financial advisor might be for you if you meet the following:
- If you are unable to control your urges when market swings happen (or you cannot ignore looking at the market in general)
- If you don’t like doing a minimal amount of homework to determine the right asset allocation and location of funds to avoid taxes in the future
- If you aren’t yet convinced that low-cost investing is a good thing.
I’d love to hear your thoughts on this. Do you completely disagree? Are you on the same side? Leave your thoughts below.TPP