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I realize that, despite what I write about, the vast majority of you will decide to choose a financial professional to assist you with your investment portfolio and reaching your long-term financial goals.  Going to see a Financial Advisor can be an intimidating experience.  You are coming in with limited knowledge of the financial markets, and you hear from the financial media and read in financial publications that the market is poised to go up, dive with a correction, or consolidate (i.e. unchanged).  The “noise” causes confusion.  Not to mention that the jargon utilized in the investment world is difficult to get up to speed quickly.  Your Financial Advisor should be able to explain his/her approach in layman’s terms, explain available services, and discuss the fee schedule of the firm.  Luckily for you, I have prepared a list which you can prepare for that meeting in 45-60 minutes and be armed with better questions and a foundation in the workings of the financial markets and some of the terminology.  Just so you know, I would say that if you perform this exercise, you will most likely be in the 90th-95th percentile of retail investor knowledge.  Here is the list of questions with links to past posts on the blog:

List of Questions

1)       How do you approach tactical versus strategic strategies for reallocating ones investment portfolio?


You should start with this question for one reason only.  There are a great deal of Financial Advisors that recommend that you invest for the long-term and not worry about temporary bumps in the financial markets.  However, they make changes to your portfolio each quarter.  If you have 20+ years to retirement, you really should not be making changes so often.  The world is always going to be uncertain.  You need to build a portfolio with the intention to make some tactical changes annually (make sure you are at your target allocations to each asset class).  Strategic changes should really only occur if a major life event happens or the market reaches an inflection point.  It seems like over time, there are really major market moving events every 5-7 years.  Think about the financial crisis in 2008, the bursting of the Internet Bubble in 2001, the Asian Contagion and Long Term Capital Management in 1997-1998, and the recession of 1991.  These events really moved the markets and necessitate a close look at your investment strategy.  Most of the current events are really “noise”.  They are only temporary influences on the financial markets.  Refer to this post for more information:  https://latticeworkwealth.com/2013/08/04/todays-news-should-prompt-you-to-adjust-your-entire-investment-portfolio/.


2)      How do you go about constructing an investment portfolio for me?

Nowadays there are many different options for investors that are “set it and forget it”.  One example is the life stage funds offered by various mutual fund families.  The ETF providers also have model portfolios based upon passive investing strategies.  Your Financial Advisor should be able to explain why your risk tolerance and financial goals require a different investment portfolio.  Are those changes to common models marginal or are they going to provide value for you?  For more information regarding the construction of an investment portfolio can be found here:  https://latticeworkwealth.com/2013/07/16/how-to-create-an-investment-portfolio-and-properly-measure-your-performance-part-1-of-2/.

3)      How do you calculate the fees that I will pay in both percentage terms and absolute dollars?


I have spoken at length about how fees can really lower long-term performance of your investment portfolio.  Most financial services firms will provide you with an AUM fee in percentage terms.  You always want to convert that percentage into the actual dollars you will pay.  Therefore, if you have a $750,000 portfolio and your AUM fee is 1%, you would pay $7,500 per year for the advice of the Financial Advisor.  Here is a link to a further explanation of this concept:  https://latticeworkwealth.com/2013/07/11/is-learning-about-investing-worth-it-how-about-224000-or-320000-worth/.  Fees lead to an opportunity cost because you could have invested those fees in the stock market yourself.


4)      Will you provide me with a blended benchmark to track my investment performance?  Will you highlight both absolute returns and relative returns in regard to my selected target annual rate of return on my investment portfolio?


Most Financial Advisors will speak with you during quarterly meetings in what I refer to as a vacuum.  What I mean by this is they only talk about your absolute returns.  What are absolute returns?  Absolute returns are nothing more than what your portfolio earned during the year.  The Financial Advisor will let you know how that compares to reaching your selected target annual return to meet your financial goals.


Well, there also is the concept of relative returns.  Remember that whatever asset allocation your Financial Advisor recommends, you could just buy an ETF or index mutual fund that invests in all the members of that asset class.  For example, if your Financial Advisor wants you to invest a piece of your portfolio in small cap stocks, your other option is to simply invest in an ETF or index mutual fund tied to the Russell 2000 or S&P 600 indexes.  If the actively managed mutual fund or separate account that your Financial Advisor recommends does not achieve the performance return of one of those indexes, you “lost” money on a relative basis.  Yes, you did not actually “lose” money if that actively managed fund component goes up.  However, that asset manager should be able to beat the index.  That is the only reason you would select actively managed mutual funds.  Unless they can beat the market over the long-term, there is no reason to choose that option.  You can do a “no-brainer” and invest in the whole index.  The importance of blended benchmarks is that it shows how well your Financial Advisor is doing in terms of helping you reach your target annual return.  Last year the S&P 500 was up 16%.  Thus, if you owned a large cap mutual fund that did not achieve that return, your relative performance is lagging the index.  For more information on blended benchmarks, please refer to this post:  https://latticeworkwealth.com/2013/07/19/how-to-create-an-investment-portfolio-and-properly-measure-your-performance-part-2-of-2/.


5)      How do I calculate the value you provide from recommending a given asset allocation for my investment portfolio?


If we take a concept from economics, you have probably heard that there is no such thing as a “free lunch”.  While this is true in most cases, when it comes to investing, the closest thing to a free lunch is investing in US Treasury bills, notes, and bonds.  When you are finally hitting retirement, you could simply buy 10-year US Treasury notes and live off the interest.  Most individual investors are not satisfied with this investment return.  With that being said, US Treasuries are backed by the full faith and credit of the federal government.  They are among the safest investment on the globe.


When you go to a Financial Advisor, you are paying him/her to earn what I refer to as an incremental return.  For example, if you are retired and your target investment return is 5.50% net of fees; your Financial Advisor will set up a portfolio to help you earn that return.  Let’s say you reach the 5.50% hurdle in your first year with your Financial Advisor.  How much money did your portfolio earn?  It turns out that this is a trick question.  You really only earned the incremental return which is 2.92% (5.50% – 2.58%).  The yield on the 10-year US Treasury note closed at 2.58% on August 9, 2013.  Therefore, if your Financial Advisor charges you an AUM fee of 1%, you are paying him/her 1% in fees to earn an extra 2.92%.  If you look at things in this manner, you will not that your fees are quite high when you do not compare the AUM fee to the investment portfolio solely. Remember that you already have the money, so it is really a moot point and irrelevant for purposes of calculating the value provided by the Financial Advisor.  Please refer to the following post for additional information: https://latticeworkwealth.com/2013/08/07/are-your-financial-advisors-fees-reasonable-here-is-a-unique-way-to-look-at-what-clients-pay-for/.


6)      How do you arrive at expected returns for my investment portfolio?  Do you tend to use arithmetic averages or geometric averages?


The calculation of your target expected return is of paramount importance.  It determines whether or not you have enough money to comfortably reach your financial goals.  Arithmetic and geometric averages may sound like complicated concepts, but they are really quite simple.  An arithmetic average is simply adding up the returns for each year and dividing that number by the total number of years used.  Arithmetic returns are fine for trying to arrive at an expected return for any given year.  However, once you introduce a negative return into that series, the arithmetic average is of no use.  Geometric averages measure what is referred to as terminal values.  Now terminal values is a fancy way to say what return you earned over time that equals how much money your investment portfolio is worth at the end of the period.  I will give you an example to make this more concrete.  Let’s say you invest $10,000 into the stock market, and the stock market goes down 10% in the first year and then goes up 10% in the second year.  How much money do you have at the end of year two?  You have $10,000, right?  No.  Do not worry; most people get that question wrong.  Take a look at the math.  If your $10,000 portfolio goes down 10% in the first year, you have $9,000 ($10,000 * (100%-10%)) at the end of the year.  If your investment portfolio goes up 10% in the second year, you have $9,900 ($10,000 * (100%+10%)).  You actually lost 1% over that period.  It is easier to think of in more extreme returns.  What if you owned a stock that went down 50%?  How much does the stock need to go up to get back to even?  Well, you have half as much money, so you need to double that amount.  It works out that you need a 100% return to have the same amount of money in your brokerage account.  Why is this important?  Many Financial Advisors will tell you that you can earn 8-9% if you invest in stocks.  Well, the long-run historical average return of stocks is somewhere around 7%.  It depends on what stocks you include in the index.  Now the recent past has been great for most every stock.  With that being said, there is always the chance that the market will drop significantly in any single year.  When the S&P 500 went down almost 40%, you would have needed to earn 66.6% just to get back to even.  Now remember that your Financial Advisor told you that you can expect to earn 8% or 9% as a target return over the long-term.  The stock market rarely goes up that high.  It usually will take 4-5 years to earn that 66.6% return.  For each year it takes to get back to even, you are missing out on the assumed compounding over the period.  Thus, you will be behind your long-term plan to reach your financial goals because you are only trying to get back to even.  For more information on this concept, please refer to this post: https://latticeworkwealth.com/2013/07/08/double-edged-sword-of-the-power-of-compounding/.


7)      If I have a long-relationship with you to manage my money?  How will fees add up over time?  Am I making a “bet” that you will beat the financial markets?


This topic is always the hardest to discuss.  When you choose a financial professional, the ideal relationship is for the rest of your lifetime.  If you are retiring soon or just retired, you are likely to be dealing with the Financial Advisor you select for 20+ years.  It is a big decision because you will be paying AUM fees for the rest of the relationship.  You need to know what you are getting into and feel comfortable with that Financial Advisor because they are helping you live your golden years in the way you always envisioned.  How do you go about determining the value that the prospective Financial Advisor will provide over your retirement years?


You need to use the economic concept of opportunity cost.  If you have a retirement portfolio worth $1 million at the start of your retirement and your Financial Advisor charges you a 1% AUM fee, you will pay $200,000 ($10,000 * 20 years) over the course of the relationship.  Well, think about that.  If you managed your own investments, you would not need to pay that AUM fee.  You could take that $10,000 and invest that money in an ETF or index mutual fund tied to the S&P 500 and earn the long-term historical average of that index which is roughly 7%.  Now if you did that, you would have roughly $425,570 at the end of 20 years.  As you might imagine, dollars 20 years from now will not be worth as much as they are now.  So how do you relate your opportunity cost into present day dollars?  You do a process called discounting.  If you assume inflation will equal 3.25% over the course of those 20 years, you would have $224,475 in today’s dollars.


Now let’s reference your beginning portfolio balance.  You can think about this in two ways.  First, that is the cost of you not managing your own investments which is a decision that only you can make.  You need to measure the utility of your leisure and your risk tolerance (emotional about money and acting rashly at times).  Second, you are making a $224,475 “bet” that the prospective Financial Advisor can beat the market.  Remember you could just choose an asset allocation yourself.  You will earn the index averages minus the expense ratio of those investments.  Most expense ratios on passive options are 0.20% or less.  You will never beat the market averages, but you avoid the chance that your Financial Advisor recommends a poor choice for your asset allocation that significantly underperforms its proper benchmark.


Now if you do not have $1 million or the AUM fee is not 1%, you can easily calculate how much your present value is.  Simply take the ratio of your investment portfolio divided by $1 million and multiply by the AUM fee as a number.  Here is an example:  let’s say you have $250,000 now and your AUM fee is still 1%.  Your present value would be $56,370 (($250,000/$1,000,000) * 1.  If you compare that to your entire portfolio, the amount is approximately 22.5% ($56,370/$250,000) of your portfolio value.


There is no reason why you cannot work with a Financial Advisor for a couple of years and then take the reins once you learn from him/her and get comfortable with the volatility and workings of the financial markets.  You can seek out a financial planner or an independent Registered Investment Advisor (RIA) who charges an hourly fee.  You could go to see that financial professional and pay may $200-$250 per hour.  You might spend two hours at year-end and maybe see him/her once during the year when current events make you want to sell all your stocks, bonds, and other assets.  That financial professional can probably “talk you off the ledge” in one hour.  If we look at that in totality, you would pay that type of financial professional $600-$750 over the course of the year.  Looking back at our hypothetical portfolio of $1 million with a 1% AUM fee, you would be paying $10,000 to the Financial Advisor.  This option would save you over $9,000 in fees.  Try to remember that the choice is not manage your own investments or turn it over to a Financial Advisor.  There is a “gray” area where you use a trusted financial professional to bounce ideas off of.  Therefore, there is a spectrum of choices when you are looking at how to ensure that your investment portfolio will allow you to reach your financial goals successfully.


As you can see, you should be quite comfortable and more confident going to speak with a prospective Financial Advisor.  Keep a few things in mind though.  You spent about 60 minutes doing a crash course in learning the fundamentals of portfolio construction and fees.  The Financial Advisor has years of experience and deals with clients every single day.  So if the Financial Advisor does not understand the questions, does not know the answers, thinks the questions are not relevant, or tries to steer you away from looking at fees and relative returns, I would seriously consider looking for another Financial Advisor.  These types of questions are what a high net worth client would ask.  You may not have $5 million+ to invest, but there is no reason why you cannot ask similar questions.  It is your hard-earned money, and you deserve exceptional service no matter whatever the amount in your investment portfolio.


I leave you with this link to lighten the mood and make yourself proud:  https://latticeworkwealth.com/2013/08/06/when-it-comes-to-your-investments-are-you-smarter-than-a-14-year-old/.  You spent roughly 60 minutes reading and can count yourself as knowing more about investments and fees than 90 or 95 people out of 100.  As an aside, if your Financial Advisor uses financial jargon that you do not understand, you must ask for an explanation.  Do not pretend to know everything.  Asking questions is a sign of intelligence.  You will have the foundation after reading this to know you are asking intelligent questions.  Best of luck to you when you depart to meet with a prospective Financial Advisor!  By all means, you can feel free to take this list of questions with you to help you learn more about the Financial Advisor and the services that his/her firm offers.