Some financial advisors try to bowl you over with fancy language. Disarm them – and arm yourself for your future – with a few simple questions.
One complaint I hear as a financial advisor is that investment jargon – ETFs, P/E ratios, DRIP plans and other terms loaded with capital letters – bores, confuses and overwhelms people seeking advice.
To stop the buzzing in your head, apply the 80/20 rule, a.k.a. the Pareto Principle, which states that in most situations 20% of invested input drives 80% of the results. For example, 80% of the time you wear 20% of your wardrobe, or 80% of the meals you cook come from the same 20% of your recipe collection.
The principle applies perfectly to investing. Most (maybe even 80%) of your long-term financial success stems from your understanding three simple factors: asset allocation, fees, and performance.
Ask your advisor the following three key questions:
1. “What is my asset allocation?”
The mix of stocks, bonds, hard assets and cash you create, known as your allocation of assets, ranks as perhaps your most important investment decision. Studies suggest that asset allocation drives long-run performance and explains roughly nine-tenths of your returns’ variability over time.
My favorite asset allocation rule comes from Vanguard founder John Bogle, who ties optimal bond-to-portfolio percentage to your age. At age 40 you commit 40% of your portfolio to bonds and 60% to stocks, for instance. Allow wiggle room to accommodate personal circumstances and your stomach for portfolio gyrations.
2. “What are my total fees?”
Even a small increase in portfolio maintenance fees adds up fast. For example, over a 30-year period, assuming 6.5% compound annual returns, each additional 1% in fees reduces the end value of your portfolio 25%. Hard to keep calm facing that cost.
Fees come in many forms. You may pay a financial advisor a percent of assets under management, commissions, or an hourly fee. If you invest in mutual funds or exchange-traded funds (ETFs, mentioned above) that track an index but trade like stock, then you pay underlying expense ratios, or what it costs an investment company to operate a mutual fund.
As I mention in a prior piece, actively managed funds almost always charge higher fees than passive index-like funds, despite weighty evidence that they don’t consistently beat the market.
Other types of fees can include commissions, trading spreads, loads (a sales charge or commission on a mutual fund), and even tax consequences.
Focus especially hard on the all-in fee, or every cost involved in your financial transactions. Find out what the advisor charges and any additional fees from the investments the advisor steers you toward.
Work with an advisor who focuses on index-like strategies to help keep all-in costs to 1.4% or less. Many active portfolios’ total fees are north of 2.5% – generally 1% for the advisor and 1.5% in active funds’ fees.
The bargain-basement approach calls for using index funds on your own. Bear in mind that a single bad decision on your own can wipe out way more principal than the 1% you pay to the right advisor.
3. “What was my portfolio’s performance?”
If you set the right asset allocation and keep fees low, you don’t need to review your portfolio every month. Close each year with a review of your portfolio’s annual and inception-to-date performance to spot any needed changes to either your annual rate of saving or spending.
This holds especially true once you retire. Even if in retirement you spend 4% of your portfolio a year, adjusted for inflation, studies show that spending less after particularly tough market years increases the odds you won’t outlive your money.
By the way, price-earnings (P/E) ratios mean the price of one share of a company’s stock divided by how much the company earned per share over the previous year. Dividend reinvestment (DRIP) plans allow investors to reinvest dividends. Now these two won’t confuse or overwhelm you.
Learning to ask – and answer – these questions also increases the odds of your financial success.
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Manisha Thakor is the CEO and founder of MoneyZen Wealth Management in Santa Fe, N.M. – an independent boutique advisory firm focusing on the needs of high net worth women and families. Manisha regularly shares her financial insights on her blog, and her work has been featured in a wide range of media outlets including The Wall Street Journal, Forbes, The Boston Globe, The Chicago Tribune, MORE and Glamour. She is the author of two personal finance books aimed at women, and often appears as a guest on national television. Manisha earned her MBA from Harvard Business School, her BA from Wellesley College and is a Chartered Financial Analyst
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