Since advisors are paid to provide advice, an investor's job
is to determine who will provide the best advice in the
believes that the honor of advising clients must be earned by
the quality and quantity of information provided at the beginning
of the evaluation process. In our opinion, the better the information and the
resulting education, the more likely an advisor will provide
the highest level of advice in the future. After all,
the best way to learn is to teach.
Many investors believe that all passive advisors
will give equal quality advice, have an equal understanding
of the principles and strategies of passive investing,
and will provide equal reporting and service in the future
even though they have different fee schedules. They may assume that
they have found a free lunch.
Investors should carefully consider their decision
as to whom they select to manage their life savings, because
not all advisors provide equal expected returns net of
all fees, portfolio risk and advisor risk.
It is our opinion, that entrusting your
hard-earned money to the lowest bidder may involve additional
risks. There is a fair price for quality
The following is a recap of a phone conversation that occurred on November 20, 2009 between an IFA advisor and the individual referenced in this case.
Bad advice can be very expensive! A wealthy gentleman was about to invest with IFA when he came across the web site for a cheaper advisor. Basing his investment decision solely on the difference of fees, he signed up with the cheaper advisor.
The client had recently received roughly $20 million from the sale of his business. On March 3, 2009, when the DJIA closed the market that day at 6,764, he instructed the advisor to invest his $20 million in a portfolio of DFA funds. He had heard that Warren Buffett had said that investors should be fearful when others are greedy, and be greedy when others are fearful. Being fearful, the cheap advisor refused to invest the funds. His advice was to wait until the time when the advisor believed the markets had "leveled out." The advisor told the client he had many years of experience and that the client should "trust his judgment". After a long slide begininng from a high point on October 9, 2007 (DJIA close of 14,164), the market hit the bottom on March 9, 2009, closing at 6,547 (source: Wikipedia). On November 18, 2013, the Dow Jones Industrial Average closed at 15,976, according to Yahoo Finance.
The client stayed in cash as of November 20, 2009, and as he calculated, missed out on a $9 million increase in his portfolio value. Once he computed his 45% lost opportunity, he decided to fire the cheaper advisor. The client's mishap is roughly equal to 200 years of his annual fee savings. Investor returns often vary widely from fund returns, primarily due to unwise investor behavior. Good passive advisors are supposed to prevent this behavioral finance faux pas, not encourage it. Not all advice is the same.
The following exchange between a low-cost advisor and
his client revealed the high
costs of poor advice. The client eventually
stated that "he
would not stay there, even if it were free."
(Dated Feb. 1, 2005):
..."I need more
than a few sentences in terms of reporting and analysis
of each quarter's activity. ..
Your bearish sentiment
about the US economy has led to a market-timing strategy
that's hard to reconcile with my belief in passive index
I realize that you were trying to
protect me by recommending an extremely defensive allocation
of 30 [stock]/70 [fixed income].
[Investment Advisors] have made the point that my modest
equity allocation has cost me well over $1 million of
This is terribly frustrating
since, as you know, big upward moves come in a relatively
small number of days and if you're not in the market,
you miss out on them." ... Perhaps your worst fears
about the economy will come to pass and I'll regret having a
larger equity allocation."
(Dated Feb. 2, 2005):
"You're betting against some
of the brightest and richest minds in the business,
Buffet, Templeton, Gross, Grantham, Roach.
The weakness of the DFA models is
the assumption that the numbers are constants; they
are not. [To IFA's knowledge, DFA has never made
such claims.*] LTCM's [Long
Term Capital Management's*] 1998 blow-up illustrated
that similar models [to those of DFA] can completely
fail; one of their [LTCM] Nobels is on DFA's board.
I've made a difficult decision. I'm
not going to tell clients the risk anymore because it's
not good for my business...
I'll just give them the DFA numbers
and tell them there's no guarantee of a repeat but that's
the best we have, so don't underweight equities. It's
not my money."
* added comments
This cheap advisor appeared to
be bearish on future stock returns
and questioned DFA's model
for capturing the returns of
globally diversified capitalism.
This type of sentiment runs counter
to the basic ideas behind investing
in passive funds in the first place.
time of this email in February
2005 to August 2006, the S&P
500 Index was up 10.36%, a slightly higher return than the 85 year, 10 month annualized
return of 9.73% for the
period ending October 2013. Bad advice
can be very costly.
A great example of how expensive bad advice can be comes from
comparing the returns and growth of wealth of different index portfolios in 2003. If one advisor
had advised a client to invest in an allocation that was equivalent to
IFA Index Portfolio 30, they would have earned an 18.29% return for the one year period of 2003.
If the client had scored a 60 on the risk capacity survey and had invested in
an Index Portfolio 60 on Jan 2, 2003, they would have earned 30.97% for the one year ending Dec. 2003, or a 12.68% annual return difference. A
low cost advisor cannot lower his fee enough to make up for
this difference. If the client from the above email had a $7
Million portfolio, as IFA was told, he would have ended up with a $887,909 less in one year
of returns. (source: IP60 - IP30)
Some advisors disagree with IFA on the value of tax loss harvesting, claiming that it offers no real value because all it accomplishes is resetting the cost basis to a lower level, meaning that taxes will ultimately be paid, and perhaps even at a higher tax rate. Of course, this ignores the possibility of an investor holding his equity positions for the remainder of his life, wherein he can benefit from the realized losses while his heirs receive a step-up in cost basis upon his death.
Furthermore, IFA encourages tax loss harvesting due to the possibility of using the losses from one asset class to offset gains in another asset class. For example, in the one year period ending Dec 31, 2007, REITs were down about 19% while emerging markets were up 36.0%. Simple rebalancing would have incurred capital gains costs in emerging markets, while tax loss harvesting of the REITs mutuam fund would have allowed at least part of this cost to be offset.
IFA's position is that harvested tax losses provide a real value to investors, even if it is only postponement of tax payments, simply due to the time value of money. Furthermore, IFA does not speculate on the future direction of tax rates.
Since tax loss harvesting can involve a complex set of trades, some advisors may not want to subject themselves to the risk of something going awry with the trades where they would have to cover the cost in order to make the client whole. Certain advisors state they will perform tax loss harvesting but only if the client requests it. IFA, on the other hand, proactively offers it to all clients for whom it makes sense. However, IFA will not perform tax loss harvest trades without the client's explicit consent.
So, it is good to remember that bad advice can be very expensive and there ain't no such thing as a free lunch (TANSTAAFL) -- even amongst DFA advisors.
Unwise to pay too much…
But it's worse to pay too little.
When you pay too much, you lose a
little money - that is all.
When you pay too little,
you sometimes lose everything, because
the thing you bought was incapable of doing the thing
it was bought to do. The common law of business
balance prohibits paying a little and getting a lot -
- it can't be done.
you deal with the lowest bidder, it is well to add something
for the risk you run. And
if you do that, you
will have enough to pay for something better. "
Before you make a decision about using any advisor, you should CAREFULLY
investigate the differences between fees charged and services provided. It is
unwise to pay too much, but there are potential hazards for paying too little.
IFA knows that clients expect plenty for the fees they pay. Value-added benefits
for a fee of 0.9% for the first $500,000 and a tiered discount on larger
assets under management should include a well-run office space with a professional
and qualified staff that will:
efficiently execute and maintain the integrity
of risk-appropriate investing, incorporating the sound
ensure timely, accurate buys, rebalances,
tax loss harvesting, glide path, account monitoring, and reporting
maintain sufficient errors and omissions
Many advisors like to put a "spin" on
the DFA approach. They attempt to convince investors that they "have
a better solution" than DFA with strategies like "market
timing" or fund substitutions. Such
strategies should be skeptically analyzed, with insistence on
statistically significant data that these alternatives will actually benefit investors.
Index Fund Advisors employs an approach
that follows DFA strategies without attempting to do
it better than Fama and French. We try to educate our
clients and prospects and provide a solid platform for successful
investing. Our extensive web site and President Mark Hebner's
book demonstrate our understanding of how
capital markets work. Therefore, IFA may be considered your
minimum or near zero risk advisor.
stock market has plenty of risk to manage as it is. Think twice
before adding an additional layer of risk to your portfolio
in the form of higher "investment advisor risk."
In our opinion, investors must determine an overall
risk budget, which includes the risk allocated to an investment
advisor and the risk allocated to their index portfolio. In our opinion, a client
of a low-cost DFA advisor may consider lowing the risk exposure
of their index portfolio by about 15 points out of 100 on
the IFA Index Portfolio scale, adjusting downward for the additional
risk of a low-cost advisor.
If price was the only thing that mattered, we would all be driving Yugos.
IFA fees are negotiable. There have been special situations where an IFA employee resigned or was terminated from IFA and that employee did not comply with IFA's confidential information, trade secrets and privacy policies. It is also possible that previous IFA employees may used that confidential client information to solicit IFA clients to become clients of another firm. IFA may take legal action to enforce client confidential information, trade secrets and privacy policies. In addition, IFA has the discretion to negotiate and may substantially lower its advisory fee to those special situation clients as an additional incentive for those clients to remain with IFA.
To learn more about Index Fund Advisors
and a Fair Price for Advice, visit ifa.com.