OPINION | SAVE YOURSELF: Passive-investing strategy can pay off in years ahead

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Last week, we got the sad news that David Swensen, chief investment officer of the Yale University endowment, passed away on May 5. He was famous for the performance of the Yale endowment relative to its peers. In fact, six of his proteges from his office went on to lead other endowments that were in the 15 top-performing endowments in the country.

For folks about to retire and make decisions about how to manage their retirement savings, I would start by listening to Swensen’s advice: “Unless an investor has access to incredibly high-qualified professionals, they should be 100% passive — that includes most institutional investors.”

In simpler terms, David is telling investors that they should buy investments that are expected to perform at the market average.

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Until recently, this wasn’t a practical option for retirees. Let’s say you had money in your workplace retirement account like a 401(k) or 403(b), and when it was time to retire, you rolled the money out of the plan into an account to be managed by an adviser. And it was very much actively managed, incurring hefty fees paid to both the adviser and to the mutual funds.

For some perspective on those fees, let’s take a $1 million portfolio at retirement of half stocks and half bonds. It grows by 4% (before fees), but the adviser charges 1% and the mutual fund costs are an additional 0.5%. The account balance increases $40,000 but then is reduced over the year by $15,000 in fees. The fees are a true cost to the portfolio if we assume that the adviser and mutual funds don’t offset their fees by providing higher risk-adjusted returns.

Choosing to roll your retirement savings into an account managed by an adviser is still pretty popular, but there are alternatives that allow retirees to evaluate why they want to hire an adviser, what they are willing to pay and what value they expect to get out of that relationship.

But first, let’s lay out the alternatives. There are four as I see it.

First, you can leave your money in the workplace retirement plan, like a 401(k). And how convenient it is that many of those low-fee passive funds that Swensen mentioned can now be found in the investment menus of many Arkansas companies, hospitals and government entities.

Unfortunately, while the low-fee passive funds are accessible, the plans themselves might not be low-fee, which is why leaving money in the retirement plan would not be my top option in the long term. I think it is a great short-term place to park your money until you make a decision about what you want to do long-term. In a retirement plan, you are likely paying administrative fees for things that you don’t need to be paying for when you terminate employment. Let’s say all fees, including the mutual fund fees, add up to a half percent. On a $1 million portfolio, that is a cost of $5,000 per year.

Second, you can roll the retirement account into a self-managed individual retirement account (IRA). You can still buy the same passive funds — like a target date fund, or a group of passive funds that buys the U.S. and international markets and the bond market — that you were investing in before, but now you get to avoid those retirement plan administrative fees. With a Vanguard, Schwab or Fidelity rollover IRA, you just pay the cost of the mutual funds, which in many cases would add up to a total fee of 0.14% or less. On a $1 million portfolio, the cost of 0.14% is $1,400 per year.

For those unsure of whether they can manage their own money, here’s a cool hack. Maybe move a small amount from your retirement account into a rollover IRA during that one to two years of learning. Take $30,000-$100,000 and see what it’s like to manage it on your own. You might find it’s not all that hard.

Third, consider a robo adviser or low-fee personal adviser services. For instance, Vanguard charges 0.3% to manage your account and get access to certified financial planners for help on required minimum distributions and investing. When you combine that 0.3% and the cost of passive investing of 0.14%, then that 0.44% might be worth it for a little more help and peace of mind. On a $1 million portfolio, the total cost of this option is $4,400 per year.

Finally, you can roll your money into an IRA managed by someone else. As discussed before, between the 1% investment advisory fee and a 0.5% mutual fund fee, on a $1 million portfolio, the total cost is $10,000 to the adviser and $5,000 to the mutual fund.

OK, so the cost is significant, but depending on what you are paying for, it could be worth it. A pure investment adviser is getting paid to just manage your money, and many of them operate on the assumption that they can generate higher returns on a risk-adjusted basis than the benchmark averages, enough to more than offset their fees.

That might be right, but remember that the chances of that coming to fruition are slim. According to the SPIVA index that tracks performance of actively managed mutual funds to their benchmark, 60% did worse than the market average in 2020, and 75% did worse over a five-year period. These mutual funds cannot overcome the costs of their own fees, and most likely, investment advisers managing client funds can’t either.

If you do hire someone just for investment prowess, it probably pays to get periodic independent evaluations of that performance. Andy Terry, chartered financial analyst and professor at the University of Arkansas at Little Rock, does those evaluations for endowments and investors. He simulates the historical investment allocation and dollar deposits using passive funds that buy the entire market at a low fee. Whichever one ends up with more money “wins.” He says that every time he goes into one of these analyses, it’s like walking up to the blackjack table. Maybe this one will be the winner?

I asked him how many of these portfolios he has evaluated that have outperformed a passive portfolio. He replied, “I am still waiting to find one.”

OK, so maybe beating the market should not be an investor’s objective. Some would argue that having another person hold your hand to make sure you don’t do something dumb with your money, like panic sell, is worth the cost of the fees. And to this, I absolutely agree. I have seen people who have missed out on the last bull market because of panic selling along the way and never getting back in.

The question is whether you could get that service at a lower cost than $10,000 per year. I’d bet just about anybody would be willing to beat that $10,000 management fee to answer your call. “Hey, Lisa, I am getting nervous about the market. Should I sell it all?” Lisa: “Nope.” “OK, thanks, check’s in the mail.” All joking aside, if you are worried about your or your spouse’s ability to stay the course, then it could be worth paying such fees.

How about financial planning? Well, there’s a potential value. Hiring a financial planner to spend 20-30 hours building a plan might be worth every bit of a $10,000 adviser fee, especially if it gets you on track to do a smart, tax-efficient withdrawal strategy over your retirement. I see a ton of value in that.

But what about year two? Should you spend another $10,000 for the financial plan that was built the year before? And then again, in year three?

So there are your options. I hope the main takeaway is to take a deep breath, do some reading and know why you are engaging in a service and what you are paying for, and to independently evaluate, on an annual basis, whether that service was delivered.

Remember, you probably didn’t get to this place of wealth without a fair amount of fee evaluation and do-it-yourself approach to many items and services along the way, such as whether and how much to spend on housekeeping, lawn care, clothes, cars, homes, etc. Why stop now? For those of us whose portfolios don’t resemble that of Yale’s endowment, perhaps we should heed Swensen’s advice.

Sarah Catherine Gutierrez is founder, partner and CEO of Aptus Financial in Little Rock. She is also author of the book “But First, Save 10: The One Simple Money Move That Will Change Your Life,” published by Et Alia Press. Contact her at sc@aptusfinancial.com.