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Pay Attention to the Details: Don’t Overlook the Obvious in Portfolio Construction

We all want to build great portfolios for our clients. But in our effort to gain a performance advantage for our clients sometimes we overlook the obvious.

In 2010, Morningstar studied the relationship between low fees and mutual fund performance. They found: “In every asset class over every time period, the cheapest quintile produced higher total returns than the most expensive quintile.”

Vanguard did a study in 2015 that measured the effectiveness of different factors in predicting mutual fund performance. They found: “The ex-ante expense ratio separated poorly performing funds from better performing funds more successfully than all other metrics…”

In another Vanguard study, they compared the returns of mutual funds in the lowest cost quartile with funds in the highest cost quartile in different asset classes over the 10 years ending in 2013. Again, the low-cost funds beat the high cost funds in every asset class.

Clearly you don’t get more by paying more. Here’s how to incorporate this reality into your investment process.

Keep a watchful eye on:

  • The internal expenses of the funds and ETFs in your portfolios
  • Ongoing trading and rebalancing costs incurred in managing the portfolios

Almost everyone understands the theoretical importance of keeping an eye on fees and expenses, but far fewer do it in practice. Yet it can make a huge difference to your clients over their investment time horizon. Here are some examples. (All transaction costs are estimates that include allowance for the bid/ask spread on ETFs.)

Let’s say you have a client who needs a standard 60/40 balanced portfolio. The average expense ratio for a balanced fund in the Morningstar database is about 87 basis points. You could buy the “average balanced fund,” or you could build a perfectly good balanced portfolio with internal expenses of under 10 basis points using ETFs. The difference is 77 basis points.

If you build your client an eight-position portfolio using ETFs, the transaction costs might be around $80. Or you could build a 16-position portfolio using actively managed funds. That might cost around $320. The difference is about 24 basis points for a $100,000 account.

If you rebalance your eight-position portfolio annually and trade one-quarter of your positions, your annual rebalancing costs could be about $20. If you rebalance your 16-position portfolio quarterly and trade one-quarter of your positions each quarter, your annual rebalancing costs would be $320. That’s an annual difference of about 30 basis points for a $100,000 account.

You can see how fees, expenses and transaction costs can add up and detract from your clients’ long-term investment returns. In the Morningstar study referred to earlier they found: “Each 1 percent in additional fees eats up 28 percent of the ending value of an account over a 35-year span.” You can see that saving even 1 percent annually could fund years of additional retirement for your clients.

My point is not to advocate for the use of ETFs or for any particular approach to portfolio management. But I do want to underscore the significant impact that paying attention to the details can have on a client’s long-term financial well-being.

It’s easy to build portfolios with many high-cost positions and trade them frequently. Some people might even equate the complexity, all the moving parts and the frequent activity with more sophistication. But, as Leonardo da Vinci said, “Simplicity is the ultimate sophistication.”

Scott MacKillop is CEO of First Ascent Asset Management, a Denver, Colo.-based firm that provides investment management services to financial advisers and their clients. He is a 40-year veteran of the financial services industry. He can be reached at scott@firstascentam.com.



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Portfolio Management Beliefs and Practices That May Harm Clients

A number of beliefs and practices have grown up in the area of portfolio management that may be detrimental to the financial well-being of clients. Here are a few of them.

The MPT problem. Modern portfolio theory is an elegantly wonderful confluence of insight and mathematics. Efforts to implement MPT have not been as beautiful as the theory itself.

To build an “optimal” portfolio you must know three things—the future expected returns, volatilities and correlations of the asset classes in your portfolio. Unfortunately, no one knows what those numbers are.

Optimal portfolios are like unicorns—they don’t exist in real life. Nevertheless, we act as though our capital market assumptions have a magical predictive quality. If they tell us to trade, we trade, thus incurring transaction and tax costs.

Let’s recognize that our capital market assumptions are guesses about the future, but the fees and expenses we incur trying to stay locked onto our optimal allocation are real.

The rebalancing problem. Even if our expectations about the future have not changed, we feel compelled to tweak our portfolios to bring them back to our “optimal” mix. This is called rebalancing.

Research suggests that its utility is dependent on factors such as time period, the direction of the market and the relative future expected returns of the asset classes being rebalanced. Yet we employ simple, mechanical rebalancing strategies that generate plenty of transactions, but add little or no value. A more thoughtful approach could improve results and reduce costs.

The style-drift problem. Just to make sure everyone knows how much we love our optimal mix, we punish active managers who commit the sin of “style drift.” Forget the fact that the manager was led astray by a perceived opportunity to make money. We want them to strictly adhere to their mandate. Even though we hired them for their skill, we want them to be closet indexers.

The asset class selection problem. Another problem is that most of us do not have a scientific process for selecting the asset classes we use in our portfolios. We just keep adding asset classes until it feels about right. Remember, every additional asset class brings with it additional transaction and tax costs.

Fear of volatility. Ah, volatility reduction. Is that a good thing, or a bad thing, or does it depend? Certainly all things being equal we’d like less volatility rather than more. But we rarely have the choice of getting the same return with less risk if Mr. Market is being efficient.

We get paid to take risk and to generate the returns our clients need; we must experience some volatility. Let’s not become overly fixated on eliminating it.

The data-mining problem. It has become popular to use our massive computing power to mine data in search of winning patterns in the historical tea leaves. Some of these patterns take the form of “factors” that, we are told, will allow us to tilt our portfolios in one direction or another to give us an edge.

In investing, there is no strategy that always wins. The future rarely replicates that past. Let’s set our expectations and those of our clients accordingly.

Conclusion. Every portfolio we manage has a client attached to it. We should examine our beliefs and practices to make sure they are consistent with the best interests of those clients.



Scott MacKillop
First Ascent Asset Management
Denver, CO

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Letting Go of Relationships

Compared with professionals in other industries, financial advisers typically enjoy uniquely satisfying relationships with their clients. One reason is that “clients for life” is more than a catchphrase. Given the myriad of critical financial issues, life circumstances, and market volatility that can occur in any 10- or 20-year period, it’s no surprise that deep relationships develop.

But what happens when it’s time to let go of these relationships so a new adviser can take over?

Time for transition
No matter how competent the new adviser, nor how well honed his or her relationship skills, the new adviser is often stepping into a situation where both the original adviser and the client are grieving the loss of the relationship. Two things can happen: in the healthy approach, the client and the original adviser mutually agree to let go of the past and foster the development of the new relationship. In the unhealthy approach, the client and/or the adviser holds on to the existing relationship for dear life, which could undermine or even sabotage the relationship with the new adviser.

For example, it’s not unusual for the original adviser to think that his or her way of doing things is best. Although a new adviser may do some things similarly, the likelihood that his or her way of doing business will be exactly the same is small. That’s true even when the new adviser is the child of the transitioning adviser. If the original adviser feels the need to swoop in and mediate, the relationship between the client and the new adviser certainly won’t get off on the right foot.

So what can advisers transitioning out of the business after decades-long relationships with clients do?

  • Acknowledge that leaving one’s career may create a sense of loss. For some, you may even go through a grieving period similar to when you lose a loved one. In such cases, it may be tempting to keep tabs on client relationships. If keeping tabs is purely personal or “golf-based”—fine. But the original adviser should avoid interfering with the professional relationship between the client and the new financial adviser.
  • Those transitioning out of the business should seek the counsel of those who have experienced the same process. Sometimes the transition out of a long-term career can lead to depression, especially in the last third of life. Another adviser who has already gone through the transition process may provide a good sounding board.
  • Plan for a transition early. Both the original and the new adviser should budget ample time for joint meetings with clients to transfer knowledge and to foster the transfer of the professional advisory relationship.

The bottom line is both advisers must do what’s best for the client—even when it means letting go.

Joni Youngwirth_2014 for web


Joni Youngwirth
Managing Principal of Practice Management
Commonwealth Financial Network
Waltham, Mass.

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Is Retirement Catching? Financial Advisers Might Soon Find Out

There’s a paradox in our industry. On one hand, we worry at the number of advisers choosing to “die with their boots on” and neglecting to put an effective succession plan in place. On the other hand, we worry about reports like the one from Cerulli Associates, which suggests that more than one-third of U.S. financial advisers are planning to leave the business over the next 10 years. Once those boomer advisers start retiring, could we see a shift tantamount to Malcom Gladwell’s The Tipping Point? It’s possible—and it could come sooner and faster than predicted.

What might hasten advisers’ retirement?
There are a number of changes taking place both in our industry and in boomer advisers’ lives that could lead them to catching the retirement bug sooner than they expected to:

  • Although many boomer advisers imagined themselves adopting a lifestyle practice, the ripple effects of various regulations, including the Department of Labor’s new fiduciary rule, may cause some to stop and rethink what the future looks like and if they want to go through the hassle of making necessary changes to their practices. It might be easier to get out while the getting is good.
  • Advisers of a certain age may begin to notice that lifelong colleagues, associates, and friends no longer attend industry conferences. These advisers are often the oldest ones at these events, and it may cause them to think twice about attending in the future. This can start them on the slippery slope to falling behind.
  • Increasingly, industry media are focusing on the benefits of technology to our business. Unless they have been diligent about keeping up with the technology revolution, tenured advisers may not be motivated enough to continue learning, leading them to fall even farther behind.
  • Clients, family and friends may increasingly ask boomer advisers when they are going to retire, while former colleagues regale them with stories of exciting vacations to faraway places. Advisers may start to realize that there’s less time remaining in their lives to do the things they’ve always wanted to do.
  • Both physical and mental health become concerns the older one gets. As mental acuity diminishes, advisers may be asked to retire for the good of the business. Or, nagging aches and pains may need medical intervention and extensive recuperation time.
  • When a spouse retires and wants to do things together or needs medical or physical assistance, advisers may be pressured to leave the business.
  • Valued clients may begin to pass away. If these are the same clients from whom the adviser derived a sense of purpose, he or she may feel dissatisfied with the business.
  • Given that the next generation of clients often doesn’t retain their parents’ advisers, and prospects typically want an adviser who will “outlast” them, assets under management may begin to decline. Advisers know that this ultimately affects the value of their business in a negative way, so they may choose to get out early.

This is the reality of growing older in a demanding and evolving industry. And though we’ve tended to believe that many aging advisers aren’t ready to throw in the towel, experiencing one or two of the circumstances on this list can make an adviser susceptible to catching the retirement bug.

But it’s not all bad. Some may be lucky enough to discover that there’s life after being a financial adviser.

Joni Youngwirth_2014 for web


Joni Youngwirth
Managing Principal of Practice Management
Commonwealth Financial Network
Waltham, Mass.

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Turning Midlife Uncertainty into Midlife Opportunity

Financial planners know that traditional retirement is a dying concept. As clients are living longer, healthier lives, a new phase of life is emerging—that time after ending a prolonged working phase and before truly slowing down. It’s a time when many middle- to late-age adults are focusing on making an impact, building purpose, and creating a legacy.

According to social innovator Marc Freedman, it’s the time for an encore career, and the organization he founded, Encore.org, is helping millions of adults make those encore careers not just wishful thoughts, but realities.

Freedman will be presenting at the Financial Planning Association’s Retreat 2016 at the Wigwam Resort in Phoenix, Ariz., April 25-28. Register before March 18 to get $100 off.

1. Encore.org is building a movement to tap into the skills and experience of those in midlife and beyond to improve communities and the world. What inspired you to create this movement?

The original inspiration was to provide more caring adults and human capital in the lives of young people who were growing up against the odds. I’d been involved in the first significant study that had been done on the Big Brothers Big Sisters program, and it showed tremendous benefits for young people who were matched with a mentor, but there were half as many kids on the waiting list for the program as were actually being served. And that raised the fundamental question about the untapped talent in society.

And that started this journey, because as soon as you start thinking about the untapped resources of talent in the country today and even more so in the future, it’s hard not to land on older people, so many of whom are looking for greater purpose. And they have a lifetime of experience and the benefits of even greater longevity. It seemed like there was an opportunity in the very specific sense of trying to improve the lives of kids, and at the same time improve the lives of older people who were involved themselves and oftentimes had a deep need to be needed.

So that was the beginning of this idea that there was a great twofer in engaging older people in ways that would build purpose and legacy, and an opportunity for people to live not just longer lives, but lives that continue to matter.

2. What role do you feel financial planners can play in the Encore movement?

An enormously important role.

Research we did last year showed that 4.5 million Americans are already in an encore career—a second act at the intersection of passion, purpose, and a paycheck—and that 21 million more give top priority to following in their footsteps.

And these encore careers, these second acts, last about a decade. So that’s 25 million people who could contribute something like 250 million years of talent to solving significant needs, and yet of the group that’s trying to go from aspiration to action, the 21 million, every time we poll them or do focus groups, the biggest barrier is not having the financial wherewithal to move from the freedom from work—that old retirement dream—to something that more closely approximates the freedom to work, to have greater latitude to do work that’s closer to their sense of purpose but maybe less lucrative than what they were doing earlier.

I think there’s an unacknowledged transition between midlife and this period that’s not retirement, but really another phase of life and work, and people are not well prepared for that transition. I think financial planners can help them do a much better job of being ready.

3. You will be speaking at FPA Retreat 2016 in April. What message do you hope the financial planners in attendance will take away from your session?

That the intersecting longevity and demographic revolutions are producing a new map of life— one with an entirely new period of productivity in what used to be the retirement years. And that’s an opportunity not just for individuals who are lucky enough to be at that phase today, but for younger generations who need to plan for a longer distance race than those of us in our 50s, 60s, and 70s today ever thought was possible.

And that ultimately, if the financial planning profession and other parts of society help this group realize their desire to continue to be productive, engaged, and living meaningful lives, that we’ll all benefit, and that we’ll have a richer, more productive society now and for generations to come.

Look for the Journal of Financial Planning’s full interview with Freedman in the April issue.

Schulaka Carly_resizedCarly Schulaka
Journal of Financial Planning
Denver, CO

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Closing the Knowledge Gap: Findings from FPA and AARP Social Security Research

SSSocial Security is a complex thing for your clients. At what age should they start benefits? What are the rules?

Turns out, Americans surveyed by the Financial Planning Association (FPA) and AARP aren’t very knowledgeable and they’re not going to planners or other experts for help. Read the full report here.

“The survey sends a clear message,” Jeannine English, president of AARP, said at a press conference Sept. 28 at the FPA Annual Conference—BE Boston 2015. “Most future beneficiaries lack the knowledge they need to make good decisions they need about Social Security.”

This knowledge gap could cost future beneficiaries many thousands of dollars and it not only affects them but their loved ones as well.

“I know from hands-on experience that Social Security is the cornerstone of any retirement plan,” said FPA President Ed Gjertsen, CFP®. “If it’s not addressed properly, beneficiaries and families can really miss out.”

They think they know Social Security, according to the research. Nearly a half of those surveyed said they are “very” or “somewhat” knowledgeable about how their benefits will be determined.

The reality is that most Americans can’t afford a financial planner, so how do we close the knowledge gap for them? That’s a question Sharon Epperson, senior personal finance correspondent at CNBC, posed to a panel of professionals at the closing general session at BE.

“Financial planners are key in helping your clients and consumers know the information about Social Security in order to make the best decisions for them,” said Gary Koenig, vice-president of financial security at the AARP Public Policy Institute.

While planners won’t be able to give all the goods away for free, Koenig suggested they get involved with virtual and in-person “town halls” AARP is planning to host across the nation for consumers who don’t have access to a planner.

The key takeaways when combining the data on what consumers said and what CFP® professionals said regarding Social Security:

  • CFP® professionals expect that Social Security will be a lower percentage of retirement income for their clients than consumers estimate, reflecting the data showing that those who used a professional financial adviser are more affluent than those who had not.
  • Consumers think they are more knowledgeable about how their Social Security benefits are determined than CFP® professionals believe their clients are; 9 percent of consumers say they are very knowledgeable compared to the 1 percent of CFP® professionals who believe their clients are very knowledgeable.
  • CFP® professionals are twice as likely to say they are very confident that the Social Security system will provide their clients with benefits at least equal in value to those received by today’s retirees (14% versus 7% of consumers).
  • CFP® professionals were far more likely to correctly identify 10-20 years as the length of time the trust fund would remain solvent (50% vs 27% for consumers), whereas consumers thought it would be exhausted earlier.
  • Nearly three in 10 (28%) CFP® professionals recommend to clients that they wait to claim benefits until age 70, but only 13 percent of consumers plan to wait that long.
  • More than 90 percent of CFP® professionals recommend that clients check their estimated Social Security benefits at least once every couple years, yet only 64 percent of consumers have done so in the past two years.

One thing consumers could do—your clients included—is sign up for a My Social Security account on the Social Security website, said Dr. Thomas Hungerford, the associate commissioner for retirement policy at the Social Security Administration.

This is where consumers could find answers to common questions about benefits, have access to their Social Security Statement (as the SSA isn’t sending out paper reports anymore) and find out if there are any errors with their earnings so they can figure out how to fix them.

“The people who are approaching retirement are probably more computer savvy, so we do have a lot of web-based resources,” Hungerford said. AARP also offers a plethora of helpful calculators and tools on its website.

According to Jeannine English, now is the time to fill the knowledge gap for tomorrow’s retirees, because “many people don’t realize how much they will need Social Security.”

HeadshotAna Trujillo
Associate Editor
Journal of Financial Planning
Denver, Colo.



Editor’s Note: Watch the full press conference here: