It's hard to understand the total value a financial advisor provides. This is not your fault. Financial advisors are notoriously bad at communicating how they can help clients.
Layer in portfolio complexities that arise when working with a socially responsible financial advisor to customize a portfolio, and the problem is even worse.
Seeing the advisory fee that comes out of your investment account can be annoying. I get it. No one likes paying a fee, especially when you can get something that on the surface is cheaper somewhere else.
Buckle up, because I'm about to get real with you. We're going to talk quantitatively about the value I provide for the fees clients pay. When we're done if you have any doubt that what you get working with me isn't worth far more than the cost, then let me know and I'll try harder. :)
Forget about socially responsible investing for a second. There are a few conventional things I can do right off the bat to improve a new client's portfolio.
On average, I can save someone 0.40% simply by swapping their portfolio into lower-cost funds*. The reason this happens is that my firm is committed to low-cost Index Funds.
Most financial advisors stick clients with Actively Managed Funds that carry expense ratios and buried 12b-1 costs approaching and sometimes exceeding 1%.
Sidenote - most active funds fail to beat their benchmarks with any consistency with high expenses being a primary driver of that fact.
Skeptic: that's not true, my funds are good.
Response: there's a chance you're correct, but much more likely is that you're either misinformed or straight-up wrong.
We can see the chronic underperformance of actively managed funds Morningstar provides for us. The chart below shows the historical performance of the S&P 500 ETF, ticker: SPY, against its best fit benchmark (barely visible blue line) and the average active manager (yellow line) which represents all mutual funds, variable annuities, and separately managed accounts, i.e., all the actively managed stuff.
That's just a fancy way of saying "I only trade when I have to".
Rebalancing serves clients so that portfolios don't trend too aggressively or too conservatively. This can happen when stock-dominated funds compound faster than bond-based funds or when the market declines and bond funds start to take up more space in the portfolio.
In the short term, rebalancing when any particular fund in a portfolio's target weighing exceeds predetermined thresholds can actually generate a higher rate of return. This happens because it forces the portfolio to consistently buy low and sell high.
In a Journal of Financial Planning report, the research found that looking for rebalancing opportunities once a week generated the best long-term rate of return compared to other rebalancing frequencies such as yearly, quarterly, monthly, and even daily!
By checking the portfolio consistently every week as I do for clients, opportunistic rebalancing generates an additional 0.39% of return**.
Do you do that? Does your current financial advisor do that?
The answer is no. The reason why it's no is that it takes software to accomplish opportunistic rebalancing. Software is expensive, time-consuming to learn how to use properly, and most financial advisors couldn't be bothered to look at a client's portfolio except when that client happens to come in for a review or when asked to.
I've looked at a lot of investment statements from folks thinking of hiring me over the years. In this discovery phase, I often see multiple accounts with the same portfolio bought in each separate account.
There are two inefficiencies related to this. First, it results in additional trading costs that could otherwise be avoided. Second, it doesn't capitalize on the tax advantages of placing specific investments in tax-free accounts (Roth & HSA) vs. placing other investments in tax-deferred accounts (IRAs) and/or taxable accounts.
On a high level, asset location can be as simple as placing investments with the highest expected returns in Roth IRAs & HSAs. This prioritizes aggressive growth in the accounts that net us the most tax-free income in retirement. Examples of investments with high expected returns could be small caps, real estate, emerging markets, or large-cap value.
Asset location can get pretty complex depending on how far we take it. Some financial planners look at how much taxable income an investment kicks off and use that as a basis for which account the investment is placed in.
For example, non-traded REITs, long-term bonds, high dividend-paying stocks, and any funds that generate substantial Ordinary Dividends all generate unfavorable amounts of income from a tax standpoint. There is a compelling case to be made that suggests avoiding buying these in a taxable account.
Unfortunately, there is no single best method as there are competing goals within the asset location puzzle. This is where a halfway-decent financial planner comes in handy. We make decisions based on what's most valuable to our clients, i.e., how hard do we really need to control for tax efficiency?
Scenario: you just retired at age 62. Nice! You've in good health and therefore have committed to delaying Social Security income. You have a 401(k) from your previous employer, an IRA with both nondeductible contributions as well as growth dollars nested inside it, an HSA to use with health-related expenses, an Inherited IRA you received from your mother who passed away 8 years ago, a Roth IRA, an annuity, and a taxable account owned by your family revocable trust.
Knowing that you need to create a robust income stream to pay the bills until you kick on Social Security benefits, which account(s) do you take income from and in what sequence?
According to relatively recent research published by Morningstar, prioritizing income from a taxable account while leaving Roths, HSAs, 401(k)s, IRAs, and annuities alone as long as possible results in an extra 3.23% of quantified added value.
The Morningstar research calculates this value using "certainty-equivalent utility-adjusted retirement income across different scenarios". Dorks! Said simply, it's like getting an extra bonus return on your portfolio.
Tax Loss Harvesting
Under Appropriate Circumstances, selling investments in taxable, non-retirement (taxable) accounts that have declined from their original purchase prices and replacing them with similar investments kills two birds with one stone.
First, capital losses can be used to offset capital gains. This can be effective for anyone trying to divest of an outdated portfolio that has grown over time but is no longer in line with their current goals. It's also effective for retirees who need to sell assets with embedded capital gains to create an income stream.
Second, capital losses can be claimed as a tax deduction against ordinary income on Schedule D of Form 1040. For a married filing jointly couple in the 22% federal marginal tax bracket, a $3,000 capital loss deduction is worth $660 off their tax bill. Best of all, any unused capital losses are "carried over" to the following year to be used either against future portfolio capital gains or as continued tax deductions.
This is all about intangible value. The best way I can define this is when I push back against something I know isn't in a client's best interest.
For example, there are tens of thousands of people across the country right now selling their investments because they're scared of how the stock market has performed this year. In 99% of those cases, they should be sticking with their investment strategies.
A big part of my job is to persuade folks to stick to their long-term plan without getting caught up in bad decisions based on what's happening in the short term.
Advice in a client's best interest often conflicts with what they've been told or what they've decided on their own. I've had countless conversations with clients over the years about everything from buying HSA-eligible health insurance on an exchange to delaying Social Security to not paying extra on their insanely low mortgage rates.
According to Vanguard research*, when a financial advisor successfully shows a client the benefits of a more efficient strategy than what the client would otherwise do, it's the equivalent of adding an additional 1.5% of return to a portfolio.
These 6 concepts & strategies aren't even the full scope of value a really good financial advisor can deliver. One of my colleagues put together a helpful graphic summarizing what I've already discussed and more.
SOCIALLY RESPONSIBLE FINANCIAL ADVISORS
Assuming a financial advisor practices 100% of everything I just mentioned (or at least half), that advisor's clients are receiving much more value compared to the advisory fee they're giving up.
For clients that care not just about investment fundamentals like asset allocation, risk, return, costs, and tax efficiency, we can take things one step further by examining the environmental, social, and governance (ESG) considerations of a portfolio.
The goal of ESG screening is to identify where individual companies lie on the sustainability spectrum. Think of corporate sustainability as a decision-making framework designed to limit or avoid unfavorable future outcomes.
For an excellent primer on portfolio sustainability, I highly recommend THIS well-written article.
Just to keep our definitions straight... Advisors use ESG Screening software to identify Sustainable companies. Once constructed, a sustainable portfolio's Impact can be measured and reported. All of this is encompassed under the umbrella of Socially Responsible Investing.
When designing any socially responsible portfolio, it first starts with a conversation about what's important to a client. I facilitate this conversation with an Impact Assessment.
Here is an example of how my firm's impact assessment might look after completion. The causes a client cares about are displayed and weighted according to importance.
Once I have this blueprint, I can compare what's most important to a client to how well (or poorly) the investments in our model portfolio reflect the client's most favored causes.
I use software to accomplish all this, and it's especially valuable during this phase of portfolio construction. From a database of every mutual fund, ETF, and publicly traded stock, I can view & rank investments that best reflect a client's causes.
If the target fund in my firm's portfolio model doesn't meet the criteria we're after, it's replaced by a more suitable fund in my trading software.
In a nutshell, that's the process. In reality, customization is a lot more nuanced. For example, I may identify 6 replacement funds in just the U.S. large cap value space that meet a client's objectives better than the target fund in our portfolio model. Options are good, but it forces me to assess each fund.
I have to look at the fundamentals to make sure it not only meets our socially responsible investing criteria but that the fund is actually good.
What is the cost of that fund, both internally as well as the cost to trade?
Does the fund actually represent the dedicated space in the asset allocation of the portfolio I'm looking for? For example, not all large-cap labeled funds are actually large cap.
Is the fund structured as an index fund, which is what we're looking for, or is it an actively managed fund?
What kind of rate of return has the fund produced historically, and what level of risk did the fund take to achieve that return?
These questions all need to be considered when customizing a portfolio, and doing this for even just a handful of funds in a portfolio build is time-consuming as well as somewhat subjective.
However, I wouldn't have it any other way.
I don't know any other firm in the country that does what I do the way I do it. That's not to say there's not someone else out there taking the same approach I do, but I do hang out with friends at competitor firms so I feel like I have a relatively good idea of what's out there.
After 10 years of running my own advisory practice, I love how unique we are. This isn't Edward Jones. You're not going to get a canned portfolio where the advisor just sits on the assets and charges you a fee.
This was a lengthier post than normal. If you made it this far, nice!
I appreciate the time you took to understand what a socially responsible investing advisor does to earn their fee. Should you have questions about your current portfolio, feel free to use the Contact link at the top of this page to reach out. I will always respond to your message with advice in your best interest.
Last, yes, I follow a process to accomplish everything I mentioned in this post.
* Putting A Value On Your Value Proposition, Kinniry, Jaconetti, DiJoseph, Zilbering, & Bennyhoff, Vanguard Research, Sep 2016.
** Opportunistic Rebalancing: A New Paradigm for Wealth Managers, Daryanani, Journal of Financial Planning, Jan 2008.