The Family Firm

By Mary A. Malgoire, MBA, CFP™
September, 2005

As far as we can see there are two primary considerations in being financially successful. The first and foremost consideration is applying good judgment when making financial decisions; the second is minimizing costs (fees, commissions, loads, etc.).

You may be surprised that I did not mention becoming a successful "investor." This is because, having a winning investment plan, while important, can easily be sabotaged by poor (or no) advice in the other financial aspects of your life. Retire too early and you may run out of money. Neglect long-term care insurance and you may depend on state and children when you are older. Set up your estate plan wrong and you may pay more in taxes than you leave to your children. So, trust me, true financial well-being is about more than just investment success.

Consider this grid, where good judgment/advice can either be present or not and costs can either be high or low:

The best and worst situations can easily be identified. Wise counsel combined with low costs is an ideal situation. On the other hand, the worst situation can be described as paying high costs and all the while making poor financial/investment decisions or getting bad (or no) advice. The boxes with question marks require further evaluation. Note, we do not distinguish between paid professional advice and being your own financial advisor. The point is access to good advice. More on that later.

First, let’s address costs. Costs, while they can’t be eliminated completely, should be kept as low as possible. Costs are actual dollars removed from your investment base due to management fees, commissions, mutual fund loads, etc. Such costs are either directly debited from your account, reducing the amount invested, or cause returns to be lower than they would otherwise be. Simply put, if the investments in mutual funds, collectively earn 7% during the year, after a 1.5% expense ratio, the return is really 5.5% to you. If, instead, the expense ratio is just .5% the return is 6.5%, a full percentage point more. On a $200,000 portfolio, 1% is $2,000 per year. Compounded over many years, this can provide a significant boost to wealth.

The box below describes how to learn if you have unnecessary expenses in your portfolio.

Investment costs are often not obvious. They are not itemized on your monthly mutual fund or brokerage statement, where it would be possible to determine what you are paying each year in commissions and management fees. As a result, many consumers feel that costs are not that important and that similar investments produce similar results. This is just not true. A great deal can be saved by keeping an eye on costs. Continuing to pay the freight on a high cost mutual fund is like running a race with a ball and chain around your neck. You must save more and spend less to build the same level of resources of someone without this burden to carry.

What do I mean by “advice”? A recommendation to buy or sell an investment is certainly “advice”. However, I would argue that the advisory relationship is much more meaningful if it includes financial planning, tax advice, and proactive contact during difficult times. A question like: “Should I sell my house now?” involves considering personal circumstances, alternatives and objectives in addition to knowledge of the real estate market as an asset class. Investors who have this level of counsel available puts them in the left half of the grid. Investors who have a simple brokerage relationship, where the broker is not privy to other financial details (such as insurance, taxes, cash flow, retirement income, etc.) and is not competent in financial planning would fall on the right side of the grid.

Focusing on the left side of the grid, there are several components to what I call “wise” counsel. First and foremost, the counselor must be competent and knowledgeable. Second, they should be independent. That is, they should not have a financial or other vested interest in what is recommended to you, or in the outcome of your decision. Absent this, the advisor must fully disclose any such conflicts and the magnitude of the conflict. And be wary of the advisor whose advice comes with an embedded high cost due to the fact that the only investments in the advisor’s tool box carry high loads and management fees. An independent advisor is more likely to recommend low cost investment products, just as you would if you were advising yourself. Obviously, if you direct your own financial affairs, the only significant question is the competency one.

Are you paying for advice you are not getting? (Top right hand box – the worst situation). Alternatively, are you paying too much for the level of advice you receive? (Top left hand box.) The brokerage industry considers that 12-b-1 fees are your payment for a broker's advice. Check your mutual funds. Did you commit to a high front or back end load at purchase? Do they carry a high (greater than .5%) 12-b-1 fee? And if you have a managed stock account, is this fee greater than .5% per year? What are you getting for what you are paying? If you believe the costs are high in your accounts, you may want to seek out a fee-only advisor via the National Association of Personal Financial Advisors www.napfa.org. Such advisors, because they have no conflict of interest, will move you toward the “Best” box, where the advice is independent and costs are minimized.

What about the investor who has made her own decisions over the years? The self-directed investor typically occupies the bottom part of the grid where costs are low. The question this person must ask is whether they, as their own advisor, are providing reasonably good advice? As the US stock market in general and technology stocks in particular ran up to lofty levels in the late 1990s, many individuals lost perspective and were drawn away from a diversified portfolio and into a buying frenzy that concentrated them in US stock and technology stocks. The subsequent market crash in 2001 left many do-it-yourself investors feeling shaken about their ability to be their own wise counsel. Others, who have been successful for the most part over the years, lose interest as they age or recognize that the significant nest egg they built should be handled with greater expertise, care and attention than they are capable of. Other important questions like, how much should I draw from retirement accounts, should be made after evaluating a whole host of considerations.

In conclusion, use the grid above to evaluate your current situation and determine if you are both getting the comprehensive advice you deserve AND paying a reasonable cost for it. If you are a do-it-yourselfer, it may make sense for you to raise costs to put a good advisor in place. This could be the single best decision you ever make. On the other hand, if you are in the box labeled “Worst”, you may “find” funds to pay for true advisory services as the advisor re-deploys the portfolio into investments with lower costs. Don’t let grid lock hold you back. Understand where you are and where you need to go.