Today, things are different.
He has a money manager. He doesn’t talk about what happened. When the subject of investments comes up he talks about his new part-time job. Charlie has acquired some serious humility.
Charlie is typical of millions of investors--- a group that might be called The Recently Burned. They are surrendering their battered investments to professionals who promise to build disciplined, diversified portfolios that will minimize risk and maximize gain. Not only that, they will build portfolios with high alpha’s and low correlations between asset classes. If that fails to impress, they’ll make sure your portfolio gets a healthy dose of mean variance optimization--- not the kind of thing you should try at home.
Some managers do it with mutual funds; some do it with collections of private managers. In the trade, they’re called “wrap accounts.” Most cost something north of 2 percent of your assets a year if you don’t negotiate a lower fee.
It’s also a booming business. According to Cerrulli Associates, a Boston firm that researches the money management industry, assets in wrap accounts have quadrupled over the last six years.
There’s only one problem. The fees exceed the possible benefit.
Here’s the math. If you line up a hundred fund managers who specialize in large capitalization stocks, the difference between the top and bottom performers tends to shrink as the investment period gets longer. At three years the difference between the 25th percentile manager and the 50th percentile manager is 1.78 percent. At 10 or 15 years, it is about 1 percent. Over the long term, an additional one percent portfolio management fee will drop the equity portion of your portfolios’ performance about 25 percentile.
It’s worse with bonds. The difference between the 25th percentile and the 75th percentile is less than one percent after only 10 years, so a one percent management fee could take your bond return from the top 25 percent to the bottom 25 percent, all by itself. Apply the fee to a portfolio of stocks and bonds and the additional cost will drag performance down about 31 percentile. That’s a lot of drag.
Even so, wraps may still be a good choice compared to the chaos of home brew money management.
So consider a simple alternative. It’s called a balanced fund. If you had simply invested in the five largest balanced funds (American Funds Income A shares, Fidelity Asset Manager and Puritan, Vanguard Asset Allocation and Wellington) your average performance over the last 3, 5, and 10 years would have been in the top 25 percent of all balanced funds and your average cost would have been less than 6/10ths of a percent.
The odds a wrap manager will do better? You guessed it, about one in four.
This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.
AssetBuilder Inc. is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and expenses carefully before investing.