When Should You Hire An Investment Advisor? Two Case Studies
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today's episode 398. It's titled, When Should You Hire an Investment Advisor? Two Case Studies.

I've had several questions recently from members of Money for the Rest of Us Plus surrounding financial plans and hiring financial advisors. Typically, I answer these questions in the weekly premium podcast episode for Plus members, but I thought it would be interesting to address their questions in a regular podcast episode to hopefully benefit you.

In this episode, we'll look at two families' investment allocation as they grapple with whether they should hire or continue to use an investment advisor. First, though, I want to address a question from a member to help set the stage. The member asked,

If I have an investment asset allocation plan, a net worth statement, and a basic understanding of how much I need to retire and how much I can withdraw each year during retirement, what else does one need in a financial plan? Well, I googled it just to make sure I didn't miss anything because I don't have a formal financial plan, but I have the elements that make up a financial plan. The first is

is a net worth statement, as this member mentioned. This is a snapshot. It's something that I do every month because I share my allocation percentages with members of Money for the Rest of Us Plus so they can see how I'm allocated as well as the trades I make.

This member also has a retirement plan. Additional elements of a financial plan could include your financial goals. It can include some budgeting. I do, or LaPro and I, we do an annual budget. We use Mint to track our spending. And then I update a spreadsheet once a month just to see what our spending has been and then track that on an annual basis.

A financial plan can include some type of debt management plan. How soon will debt be paid off or a plan to get out of debt? Financial plans typically include some type of emergency fund and how those are allocated. A big element of financial plans is insurance coverage, health insurance, disability insurance, auto and homeowners or renters insurance, life insurance.

And finally, a financial plan can include some type of estate plan, wills, trusts. This is something that Lapril and I need to update as our will is a number of years old. We put it together when our children were much younger and now they're older and our circumstances have changed. It's time to update that.

A financial plan doesn't necessarily have to be one document all in a binder. It can be as simple as a note card or just different elements. Sometimes when we have a life change, it can be helpful to visit with a financial planner or an advisor or a coach just to help us to kind of work through different elements. I've hired coaches in the past as I've made transitions, and I think that can be helpful.

Now, let's take a look at these two case studies. The first is an individual that is about to retire. This member sold his business in late 2021. They have investment assets of $4.5 million, and it's invested in a variety of different mutual funds.

Their overall allocation right now is about 27.5% in bonds and cash. And then they have one rental property, and then the rest is spread among different mutual funds. They have some allocation to mostly Fidelity funds. They have some non-US exposure through an ETF, and they have some Vanguard funds. Their overall expense ratio for their allocation is 0.35%.

This member is looking to potentially hire a wealth management firm that Fidelity suggested that he take a look at. Now they've gone through the process. The firm charges 0.75% per year. The member asked that I not share the name of the firm, but I think this is a firm as representative of investment advisors.

which is different than a financial planner. In this case, this is somebody this member is looking to hire to manage their assets so that they don't have to manage the assets themselves. And that potentially will give them peace of mind. The wealth management firm suggested that this member could easily meet their income goals of $150,000 per

a year while maintaining the principle. And so by income, that's really amounts that could be sold off. It isn't necessarily just straight income. There could be some capital appreciation there. If you do the allocation, $150,000 spent from a $4.5 million portfolio is a 3.3% spending rate.

And that's reasonable. Now, if we look at this member's current allocation and we plugged the allocation into the money for the rest of us asset allocation model, the expected return over the next 20 years is 5.6 percent with a range of two and a half percent to 7.3 percent.

The potential maximum drawdown, if there's a major sell-off in the stock market, given the current allocation, is negative 39%. If this member earns 5.6% per year, spends 3.3% per year, that leaves about 2.2%, which could, if inflation came in at 2.2% per year over the next two decades, which is certainly significant.

within the realms of possibility, then yeah, the member's overall portfolio on a real basis net of inflation would stay even. In other words, the overall portfolio would be growing every year and keeping pace with inflation if inflation comes in at 2.2% or less. If inflation ends up being closer to 3% to 4% over the next two decades, obviously,

on average per year, then the portfolio would still grow, but it would fall behind.

inflation. Now, the other consideration is what would future spending be, because that also needs to go up by the rate of inflation. And we did not get into other sources of income. This member has guaranteed sources, pension, social security, because we're not doing a financial planning analysis here. We're simply answering the member's question.

Should they hire a financial advisor to manage their assets? Whenever we hire a financial advisor, we want to ask ourselves why we're doing that. In this case, the member says, I believe using their services would result in at least a 1% higher annualized return than if I tried to do this on my own.

In other words, their reason for hiring this firm is because they think the firm will generate a higher return than the estimated 5.6% annualized return that is a reasonable possibility. And again, the range was 2.2% to 7.3% over the next two decades.

This portfolio allocation that this member has is similar to the moderately aggressive adaptive model portfolio on Money for the Rest of Us Plus that has a 20-year expected return of 5.8%, a range of 3.2% to 6.9%.

Whenever we're considering hiring an investment advisor, we want to look up any type of documentation that they have. It can include their marketing materials on their website, their brochures. For U.S.-based firms, they have to file a

an official brochure with the U.S. government, or it could be the state. And so I went through that brochure to understand more about this firm. They were founded in 2009. They use what they describe as a core satellite approach. The core investments are U.S. stocks, U.S. fixed income, and developed market international equities. And they're buying individual securities.

The member mentioned that there would be about 120 individual stocks.

small company stocks, mid-cap stocks, and some dividend growth equities. He also mentioned something pretty interesting. The holdings would be equally weighted. So each stock would get the same percentage. And those individual stocks would be part of the core allocation. Now, their recommended allocation for this retiree is 20% fixed income and roughly 80% non-retirement.

non-fixed income. That would include the stock allocation, but they have a 15% allocation to the satellite strategies. This firm describes satellite strategies as strategies that deliver a high level of active alpha, excess return, that's derived from skilled active management, or exotic beta, which would be exposure to risk factors with low correlation to global markets.

Examples they give is equity REITs, energy master limited partnerships, commodities, non-investment grade bonds, private equity, emerging market securities, and perhaps some interest rate strategies. It could include some more bond-like strategies, but generally it's trying to deliver excess return.

When I looked at their brochures, their ADV, I didn't see any information on their research process for picking individual stocks. But when we look at, is it possible that this firm could deliver 1% higher return than this member could do on his or her own? We don't know.

One potential way that the firm hopes to generate excess return is by equally weighting the stocks. They're putting a deliberate bias toward small and mid-cap stocks because the

market indices, for example, if you invest in the Vanguard Global Stock Market ETF that has both U.S. and non-U.S. stocks or the Vanguard U.S. Stock ETF, that's not the official name, but ticker is VTSAX, for example, would be the mutual fund version or VTI is the ETF version. VT is the global ETF version, but they're size-weighted.

The biggest names have a bigger weight. An investment approach that equal weights just because of the mathematics will have a smaller average size or capitalization. And then consequently, if small and mid-cap stocks outperform large and mega-cap stocks over time, then that could generate some excess return. If they don't, then that would be a performance drag.

The other way this manager potentially could generate excess return is through some of these satellite strategies, depending on whether they generate a return higher than the 5.6% to 5.8% expected return of the portfolio. The other change, though, is they're recommending an 80% allocation to stocks, and this member is currently only about 70%, so that potentially can generate some higher return.

The reality is we don't know. Whenever we hire an outside advisor, it takes some trust. So we weigh the peace of mind for not having to worry about our investments can be incredibly helpful to some individuals, whereas others, like an email I got the other day, the individual mentioned that there's a lot of people out there that want to help you with your investing.

This individual watches long videos, reads all the information, but says, I just don't trust anyone anymore. The question is, how do I know who's going to help and who is going to hurt?

And that's one of the challenges with hiring an outside advisor. I replied to this email and said, trust is a challenging thing. We never really know. So I suppose it comes down to, did the person or firm deliver on what they said they were going to do based on testimonials from others, particularly from others that we trust? Now, the problem is with an investment advisory firm, at least in the US, you're not allowed to get testimonials.

So oftentimes, if an advisor is recommended by a friend, then we can get a sense for what they're doing. But with this particular advisor, as I went through the brochure, there was no historical information that we're able to see how they have done in picking individual stocks or their core satellite approach. So as a result, the member is hiring the firm based on their promises, what they're doing,

without actually being able to see how they've performed in the past. When we hire an investment advisor, we still need to understand what's going on with their portfolio. We can't just turn it over to them as educated investors, educated allocators. We need to understand what they're doing, understand the asset classes, just so we can get that level of trust.

One of the other things to recognize when you hire an investment advisor and they're picking individual stocks, if the accounts are taxable, it can be more challenging to leave because perhaps now you have 120 stocks. Perhaps there's a low cost basis. So if they're liquidated and sold, there's a real tax consequence of that.

That is one of the challenges. In many cases, you can transfer those holdings to a different broker, but then you have all these holdings that then you have to decide. That is the downside to hiring an advisor that does select individual securities. It's more difficult to transition out of that portfolio. And then again, this member will benefit from some tax loss harvesting, but I don't know what the portfolio turnover is. And again, this will be a much smaller

Smaller average market capitalization than the overall stock market.

Should this member hire this investment advisor? Perhaps. If the member has enough trust in them, has spent enough time researching, is confident, the fee at 75 basis points is reasonable for a financial advisor, investment advisor. They do offer some other outside services and their approach, a core satellite approach, is a reasonable approach. It's one that I've seen used in the past.

But again, we don't know how well this manager has done in the past. And so there is very much a leap of faith there. Before we continue, let me pause and share some words from this week's sponsors.

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The second case study is a newer member of Money for the Restless Plus. This member writes, I had high hopes of managing my own money, but I feel stuck, and I think my portfolio is too bloated and complicated for me. I'm also sitting on more cash than I need, but I don't have a clear strategy on where to invest it. Would you advise sitting down with a financial planner, and if so, are you able to recommend someone? This member is 45.

The member closed a lifestyle business in 2021 after 14 years, provided great income, but their passion waned. The member writes, I was burned out. I decided to walk away and I'm currently taking time off and not earning any income.

I have no plans as of yet for my next endeavor, so it's entirely possible that it will take a few years. And it probably will. This individual's spouse is working. Their income there is $80,000, plus there's an additional $28,000 generated net cash from two rental properties. This individual's situation is very similar to when I left my husband.

investment advisory firm 10 years ago. I didn't really know what I was going to do. I had enough money to retire if we wanted to cut back our spending. Realistically, I knew I wanted to do something and that something needed to generate some income because we didn't necessarily want to cut our budget. We still had children at home. We had education and things of that sort. That's the same in this situation. This member, they have two children ages 7 and 11.

When you quit your job and you're relying on your investments, at least for a portion of their income, it's helpful to know how much those assets are. In this case, by my calculation, this doesn't include the rental units. There's $2.2 million in taxable assets.

About $188,000 in cash. And this member says, I keep a fairly high balance because it helps me sleep at night, especially since I'm not currently earning income. I think that's appropriate. Having a higher cash balance, knowing that that's there and we will live on that for the next year or two.

Of that 2.2 million, one of the more interesting things is 25% was in precious metals and cryptocurrencies. So there's about $250,000 in gold and silver and $268,000 in cryptocurrency. There was about $434,000 in a Schwab Intelligent Portfolio. This is a robo-advisor, and we'll talk a little bit more about that in a minute.

There's about $800,000 in the Vanguard Total Stock Market Index Fund, Admiral Shares, VTSAX. $82,000 in Ayers Capital Corporation, ARCC. This is a business development corporation. We discussed BDCs in episode 381. Then there's some small stock positions. The member mentioned, I opened and funded this account in June to consider picking individual stocks, but haven't really acted on it, so you can see by the cash.

And in that portfolio, there's another $83,000 in cash. Most of their assets, at least in terms of number of counts, are held at Schwab in Schwab's Intelligent Portfolio. This is a robo-advisor service. We looked at Schwab Intelligent Portfolios way back in episode 92 when we compared the allocation recommendation from different robo-advisors. This member has four different IRAs

some SEP and Roth IRAs for both spouses. They have two 529 plans for the two children at Schwab in the Schwab Intelligent Portfolios. They have also two custodial accounts for their daughters in the Schwab Portfolios. In addition, they have $606,000 in an individual retirement account that's in the Schwab Intelligent Portfolios and two inherited

individual retirement accounts. One that's at Bernstein in a number of funds. And then there's another one that's custody at Schwab. And it has about 100 different individual securities that it looks like this member's father had bought. Now, I don't know if this came from another advisor and this was their portfolio and they just transitioned it or this individual's father liked to pick individual stocks.

But there's $1.2 million in retirement assets. So overall net worth, not counting the rental units, is $3.4 million. This member is doing well, but they don't really have, if they're both in their mid-40s, enough to retire on. Potentially. I assume that their spending is greater than $80,000 a year, just based on the emails. But I don't know. But I'm assuming, let's say they're spending $150,000 a year to live on.

They potentially are not ready to retire yet, but they're well on their way and doing incredibly well. This member's biggest question is, is the robo-Schwab Intelligent portfolios right for me? They've already hired an investment advisor. These Schwab Intelligent portfolios have about 12 ETFs in each account. Their individual one that has 434,000 is 94% stocks.

and about 6% in cash. And this member doesn't like the fact that the cash is there, but that was the highest risk tolerance that Schwab allowed. And here's a key statement from the member. As much as I want to be a sophisticated investor, I think my temperament and buy and hold mentality is more suited to buying an index or fewer indices.

One of the challenges with the Schwab Intelligent portfolios is Schwab was just fined $180 million by the SEC, Securities and Exchange Commission, for misleading their robo-advisor clients about this cash balances. From March 2015 to November 2018, Schwab essentially mandated or had

had these forced cash allocations in their portfolio. And we talked about this in episode 92 back in 2016, because Schwab doesn't charge a management fee for their robo-advisor service. And I speculated at the time because they're using mostly Schwab ETFs that's generating enough revenue and income for them to not charge a management fee

on their service. Turns out it wasn't just that. Their process said they used a disciplined portfolio construction methodology that would seek optimal return, and they used that to figure out what the cash balance should be. When in fact, Schwab was taking that mandated allocation to cash, and it was the highest cash balance of all the robo-advisor recommendations that we looked at in episode 92, and they would take that cash to an affiliate bank

Charles Schwab Bank, presumably. And full disclosure, I have all my accounts at Charles Schwab, both the bank as well as my custody accounts. I don't use their robo-advisor service. But they were taking that cash, moving it to the bank, and then lending it out. And then they would earn more interest on those loans than they were paying on the cash balance.

Here's what the SEC's Director of SEC Division Enforcement said, Gerber S. Gruhl. Schwab claimed that the amount of cash in its robo-advisor portfolios was decided by sophisticated economic algorithms meant to optimize its clients' returns, when in reality it was decided by how much money the company wanted to make.

Now that's wrong, but that doesn't mean the portfolios are flawed. They're diversified. They use some fundamental indexing, so they have more of a value tilt. But the member needs to decide, are they comfortable continuing with Schwab intelligent portfolios? The reality is all advisors need to earn income somehow. Perhaps they charge an asset management fee or maybe they don't, but they're going to figure out a different way to do that.

Ultimately, this member needs to decide what to do. Perhaps hire a life coach or a financial planner that works more on kind of helping from a holistic standpoint, a life planning standpoint with this member, with this transition, what to do for the rest of their life. I have hired life coaches in the past, particularly at the time that I quit FEG, my former firm. I hired a life coach or two to sort of assist with that transition.

The other thing this member needs to consider is how much do you like investing? The members opened up some accounts to buy individual stocks, but hasn't actually bought very many. And believe me, I've been there. We all do that. That's part of doing experiments. I opened an account at TD Ameritrade because I was going to do more options trading. I haven't bought an option at all. I've done some other things with it, but that's okay.

Overall, this member's investments aren't that complicated. There's just a number of accounts as part of having inherited some IRAs, which could be consolidated. The individual stocks could be sold, and then the asset could be moved into a Schwab Intelligent Portfolio. There is a big U.S. weight currently that could be eliminated by investing in VT, the Vanguard Total World Stock Market ETF.

instead of having so much in the U.S. allocation. Again, you have to keep in mind the cost basis. There is a very large allocation to precious metals in cryptocurrency. I don't know what the cost basis of that is, but potentially that can be a source of additional diversification if the member believes it could take a few years to figure out other ways to earn income. The cash itself could be invested incrementally as you more formally come up with a plan to earn income.

But overall, the member's doing well. The member could use the tools on money for the Restless Plus to get some guide for kind of creating an overall portfolio. Or the member could continue to use the RoboAdvisor service or hire potentially an investment advisor. But in this case, I don't know if the assets are large enough to make it worthwhile.

because there is the additional fee, but it all comes down to why hire an advisor? Is it to generate higher returns, which typically isn't a very good reason to hire an advisor because most...

won't be able to generate a higher return than we could do for ourselves. So it's more of a question of, do we want to do it? Do we want the peace of mind of having someone else do it and not have to worry about it at all, particularly as we get older? That's a reasonable decision. But ultimately, this member needs to focus on what they want to do with the rest of their life, and they have time to figure that out.

In conclusion then, should we hire an investment advisor? It's a trade-off between trust and peace of mind. Do you trust the advisor enough and will you get enough peace of mind to have an advisor to not have to manage the asset, recognizing nothing can be on autopilot? We have to do the due diligence on the advisor. We have to understand how they're investing. We have to understand the fees.

and be comfortable that the value delivered by the advisor will be enough to generate the fees. If the fees are under 1%, more likely. If they're higher than that, then that can be a concern. We need to recognize that for any of us, most of our returns will be driven by

the asset allocation. Even for this first advisor that we discussed, the returns are going to be driven by the asset allocation, the equal weighting of the individual stocks, how much in stocks versus bonds, what are the additional satellite strategies,

Most people can manage their own assets. It doesn't have to be very complicated. It could be done with two ETFs, a bond ETF and a stock ETF, VT and BND, two ETFs. It can be that simple. But if you like investing, you can learn to diversify with additional asset classes.

And there's also the opportunity to purchase an annuity, an immediate annuity, something I was going to discuss in this week's episode with a third member's question, but we're out of time. So I'll discuss it in plus episode 398. But that's another option is to take a portion of the assets and generate that guaranteed income and take pressure off of the investment portfolio. So it's a way to create that guaranteed income source and

and then perhaps to invest the other assets more aggressively. That's our discussion then on should you hire an investment advisor? It depends. There is not a right answer. Weighing peace of mind versus trust. That's episode 398. Thanks for listening.

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Everything I've shared with you in this episode has been for general education. I've not considered your specific risk situation. I've not provided investment advice. This is simply general education on money, investing, the economy. Have a great week.