1. Not All Passive Advisors Provide the Same Advice, and Bad Advice can Easily Wipe out Years of Fee Savings.

Since advisors are paid to provide advice, an investor's job is to determine who will provide the best advice in the future.  IFA 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 advice.

2. Case In Point #1:

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.


3. Case In Point #2:

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."

An Actual Email From the Client of a Low-Cost Advisor
(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 investing.

I realize that you were trying to protect me by recommending an extremely defensive allocation of 30 [stock]/70 [fixed income].

Several IA's [Investment Advisors] have made the point that my modest equity allocation has cost me well over $1 million of lost opportunity.

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."

The Low-Cost Advisor's Email Response
(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


4. What Happened?

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. From the 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.

5. What is the Cost of Bad Advice?

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.

"It's 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. 

If 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. "

6. The Value of Paying the Right Price for Advice and Service

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 research

  • ensure timely, accurate buys, rebalances, tax loss harvesting, glide path, account monitoring, and reporting

  • maintain sufficient errors and omissions insurance

7. Do They Think They're Smarter Than DFA?

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.

The 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.