“Supposedly sophisticated people, generally richer people, hire consultants, and no consultant in the world is going to tell you ‘just buy an S&P index fund and sit for the next 50 years.’ You don’t get to be a consultant that way. And you certainly don’t get an annual fee that way.

So the consultant has every motivation in the world to tell you, ‘this year I think we should concentrate more on international stocks,’ or ‘this manager is particularly good on the short side,’ and so they come in and they talk for hours, and you pay them a large fee, and they always suggest something other than just sitting on your rear end and participating in the American business without cost. And then those consultants, after they get their fees, they in turn recommend to you other people who charge fees, which… cumulatively eat up capital like crazy.”

Warren Buffett

Primary focus: to help to help retirement plan participants make more informed decisions by promoting increased competition and transparency and more specifically shining light on unnecessary asset-based fees in the group retirement plan industry.

Most financial advisors justify their value based on their ability to consistently select the best mutual funds or stocks, whether it be by selecting the best sector, asset class, active fund manager, or all three.  However, not only is making these predictions an exercise in futility (not to mention that you’ll likely get five different opinions if you ask five different advisors), but creating this unnecessary complexity creates an excuse to falsely justify charging unnecessary asset-based “management” fees when there is no managing to do.

Here is what Warren Buffett had to say regarding this issue in one of his annual letters to Berkshire shareholders, dated February 28, 2014:

“If “investors” frenetically bought and sold farmland to each other, neither the yields or prices of their crops would be increased.  The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties.

Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions.  The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit.  So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

My advice to the trustee couldn’t be more simple:  Put 10% of the cash in short-term government bonds and 90% in a very low-cost S & P 500 index fund (I suggest Vanguard’s).  I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions, or individuals – who employ high-fee managers.

So Buffett is saying that most people don’t possess his level of skill.  Do you really believe your “advisor” is so special that Warren Buffett’s advice doesn’t apply?

David Loeper, founder of Wealthcare Capital Management, provides a similar perspective:

“Here’s the scam.  The Basic asset allocation theory that caught on was based on some long-term data and showed the value of blending stocks, bonds, and cash.  In fact, the Brinson, Hood, and Beebower study a lot of advisors chant about demonstrated that 90% or more of the variance in returns among large pension plans was explained merely by their allocation to stocks, bonds, and cash.  Therefore, less than 10% is explained by all these expensive sub-classes.  But advisors can charge more if their pie charts look more complicated touting the supposed value of “non-correlating assets” that tend to correlate a lot when you need them not to the most.

So advisors have a conflict of interest in this game by making things far more complicated than needed to justify higher fees.  And, their friends that manage the expensive products they use to fill all these pie slices have a conflict of interest because they get to charge a lot more in management fees.  Even low-fee Vanguard charges more than three times the management fee for their World Equity Ex-US ETF (VEU, 25 basis points) versus their Total Domestic Equity ETF (VTI, 7 basis points).  Or, check out the HUGE weighting semi-passive fund DFA suggests to their expensive real estate and foreign funds where they earn double the fees (or more) of other funds they manage.  The product vendors and research departments fool advisors to get more product fees and advisors often unwittingly end up fooling their clients.”

To achieve diversification, you don’t need to have a complex investment portfolio.  The Vanguard LifeStrategy Funds, for example, consist of only 4 funds:  A total domestic and international stock fund, and a total domestic and international bond fund which have nearly 18,000 stocks and bonds in total.  A more aggressive investor only needs the two stock funds which have nearly 10,000 stocks.  If 10,000 to 18,000 different securities does not provide diversification, I don’t know what does.

In reality, it is actually investor behavior rather than fund selection that primarily determines wealth.  Just think about how many people got out of the market in 2000 and 2008 only to get back well after the market had risen.  And consider Morningstar’s research indicating that while the CGM Focus Fund earned more than 18% average annual returns in a recent 10-year period, the average investor lost 11% annual during this same time period.  This type of behavior simply demonstrates that people tend to sell at the bottom and buy at the top.  Consequently, the value an advisor provides should not be based on fund selection, but rather on behavioral coaching.

Chris Carosa emphasizes the importance of investor behavior in his book “Hey!  What’s My Number?”, and cites the primary questions that influence an investor’s wealth:  when to start saving, how much to save, and when to retire – all of which a good behavioral coach can help effectively answer throughout an investor’s lifetime.  He also cites a study from the Center for Retirement Research at Boston College to support his point which notes:

“The cost of retaining a typical portfolio (57 percent in equities), rather than switching to an optimal portfolio (100 percent in equities), is $25,700, or just over four months’ salary.  As the optimal portfolio is 100 percent in equities, the cost of retaining a typical portfolio relative to an all-stock portfolio is also $25,700.  In short, regardless of the degree of risk aversion, asset allocation is relatively unimportant for the typical household.”

This blog post along with these two articles also do a good job explaining how an advisor should provide value:

Book Review:  Simple Wealth, Inevitable Wealth:  How You and  Your Financial Advisor Can Grow Your Fortune in Stock Mutual Funds

Best Investing Advice:  Just Leave it Alone

Can Clients Admit they were Wrong?  Try Behavioral Coaching

In summary, if investors simply grasped the importance of not trying to control what they can’t control (where the market is going) and focused on what they can control (when to start saving, how much to save, and when to retire), then most advisors would go out of business.