Q. What is a reasonable fee and expense for the management of a diversified portfolio? Last year we lost over 60K and over 10K was in fees and expenses, about 3% of our total investment. Our registered investment advisor switched us over to manager select accounts saying they were having better results. But I think they are costing us more and we're getting less. What, if anything, can be done to minimize the fees and expenses charged by managers, and financial companies?

-----C.D., by e-mail


A. One percent a year is reasonable. Two percent a year is "normal." And three percent a year is highway robbery. Three percent is unconscionably high. More important, it is unrecoverable. The odds management skill will add that much value?   About zero.

We can approach the "what's reasonable" question from two directions. We can examine it quantitatively. And we can examine if from prevailing industry practices.  

Let's start with the first.

There is no evidence that investment management raises returns. More than 30 years of research supports the idea of keeping expenses low and investing in broad indices. You can do that for about 20 basis points or 0.2 percent a year.

People who make their living managing assets will continue to quibble with this, noting that neither the S&P 500 index nor the Wilshire 5000 index is a real portfolio and that stocks are disproportionately concentrated. That said, the market risk in most mutual funds is greater---according to Morningstar the average managed fund has a three year standard deviation (a generally used measure of risk) that is 30 percent greater than either index.

You can also find a handful of superior funds (American Funds Washington Mutual and Fundamental, Dodge and Cox Stock and Balanced come to mind) that have annual expenses under 0.70 percent. Any ongoing fee over that is likely to be a charitable contribution to the financial services industry.

To that expense you might add the cost of having someone help you select your asset allocation and individual funds. High fees for this service are also mutually exclusive with your long-term financial health.   Advisors who charge high fees are most likely 100 percent salesman, zero percent fiduciary. High fees increase the odds that the advice, simply by its cost, will do more harm than good.

As a result, the maximum anyone should pay, including transaction expenses, is about 1 percent a year.

What are the industry norms?

Lots more. The brokerage industry targets a gross return of 2 percent a year on your assets. Thirty years ago it was commissions on stock sales. Today, it is "wrap" accounts. Similarly, the cost of mutual fund "B" shares is generally over 2 percent and the cost of the average variable annuity is over 2 percent.

These costs are part of the business model of the financial services industry. They have absolutely nothing to do with your financial success.

My personal opinion: Any cost over a total of 1 percent a year should be questioned closely.


Q. What exactly is "duration"?   Is it the length of time of the current interest rate?   Is it better and safer to have a lower duration?   I thought Vanguard GNMA would be the best to be in but it has a 4.1 duration compared to American Century Ginnie Mae Fund at 1.5.   Does it have anything to do with the internal cost fees?   Which fund is better cost and return wise?

----G.W., by e-mail


A. Duration is a technical measure of interest rate risk exposure that takes into account the size and frequency of the interest coupons as well as the stated maturity of the obligation. It is defined as "the midpoint of the present value of all cash flows to be received from a bond held to maturity, providing all cash flows are reinvested."

A 15-year municipal bond, for instance, would have a longer duration than a 15-year junk bond, entirely because the junk bond has a larger coupon. Reason--- the larger coupons move the cash flow mid point. This definition is particularly important for mortgage securities because changing interest rates work to increase or decrease how long the mortgage lasts.