Fund Portfolio too aggressive?

I cannot understand why anyone would pay a bank to set up a portfolio of funds containing unknown and questionable products in the mix. My guess is he would have been better off if he had put his money into funds like Vanguard and Fidelity, and then looked after them himself. As the situation stands, he is paying someone for "advice" and then spending a lot of time agonizing about whether that expensive "advice" was any good or not. For his next birthday, send your friend a copy of "Mutual Funds for Dummies" or a similar book.

I wonder why your friend doesn't manage his or her own money. Was the bank voluntarily hired by your friend, or is it the trustee of a trust for your friend's benefit, or what?

Your friend's portfolio lost about 6% during May. I'm also retired, and am managing my own portfolio. It lost about 7.25% during the month. The market goes up, the market goes down, but there is not much reason to get very concerned about it. The volatility is part of the ride you get when you want higher returns than the fixed-income market can produce.

That said, how about more details about the holdings of the accounts so we can make a more informed judgment?

Dave

Dave,

I don't want to go into the details, but my friend is required to have the money managed by someone like a bank.

So you don't think the loss was bad. My friend got very upset and thinks that maybe there should be less money in stocks.

Do you need a list the of funds in the account, and the dollar amount of each fund also? My friend doesn't like putting their account information out on the web.

"Funds managed by a bank." Big negative.

Someone like a bank? What's the other options?

I'll bet most his mutual funds are load funds.

If you are serious about evaluating your friend's situation you need to do some work. Go to your local library and get a copy of The Only Guide to a Winning Investment Strategy You'll Ever Need by Larry Swedroe. If your library does not have it order it from Amazon. It is not expensive and it is an easy read. This is not another "how to get rich in the market book" but rather a summary of the vast amount of academic research on investing and investments that has been done over the last

30 years with citations to the original research if you want to dig deeper. It is the best single investment book I have read and I have read many.

Among the things you will learn are:

1) The vast majority of professional money managers underperform the market so if you hire a pro to manage your money the odds are high that you will not do as well as you would if you bought an index fund that holds a large number of stocks that approximate the entire stock market. 2) Expenses are your enemy. Laudus International Marketmasters charges its investors 1.47% per year according to Morningstar. Vanguard International Growth charges its investors 0.53% per year. In addition I guess that the bank is charging at least 1% of assets per year raising the toal expense your friend is incurring to 2.47% per year. In addition the Laudus fund has a 96% turnover according to Morningstar. That means that they sell and buy 96% of securities held by the fund each year thereby incurring huge brockerage costs that your friend is paying on top of the 1.47% in expenses. Let's ignore the brokerage cost and just assume that the diffenence in expenses between owning the Vanguard fund yourself and owning the the Laudus fund through the bank is 2% per year. 2% does not sound like much but consider the effect. $500,000 invested at 7% compounded annually will grow to $1.9 million in 20 years. Reduce that return by the 2% that the bank and Laudus are taking and you will see that $500,000 invested at 5% will grow to $1.3 million in 20 years. In other words, if you can reduce your expenses by 2% per year you will have 50% more money at the end of 20 years.

Is the bank providing value by charging your friend a high fee for investing your friend's money in a professionally manage mutual fund that also charges a high fee and also incurs high brockerage costs so that your friend starts every year 2% or more behind someone who invests in a low cost index fund? I don't think so.

Is the asset allocation of 63% equity funds and 35% bond funds reasonable? I am retired and that is about what my current allocation is. However, I have a friend who retired at 40. I have another friend who is retired and in his 80's. The same allocation between equities and fixed income is not appropriate for both of my friends.

Is the drop in value that your friend experienced in May unreasonable. No. It is in line with U.S. and international markets as a whole. If your friend is going to invest in stocks he will see the prices go up and down on a daily basis, frequently for no apparent reason. You can also see swings that last much longer. The Dow-Jones Industrial Average was at about $11,700 before the crash in 2001. Today it is at $10,100;

15% less.

Note that your friend will likely see the value of his bond funds drop over the next several years as interest rates rise unless the bond funds hold bonds with short maturities.

Obviously, opinions are going to vary on what is reasonable volatility. How is the bank compensated for managing the account? Fee only, commission on product sales only, or fee and commission? Does the bank have an asset management plan? Did your friend approve the plan? Does your friend have any control or any influence on the way the bank is managing the assets? Is your friend's desired rate of return consistent with his or her level of risk tolerance? Is you friend willing to settle for CD rates of return, which are near historical lows, but offer low volatility, or is a higher rate of return needed or desired? Is your friend receiving an income stream from the investments? If so, what percentage of the assets each year? The answers to these questions, and some kine of breakdown of the assets would be necessary.

Dave

I believe the bank charges a 1% fee, no commission. The bank has different plans from aggressive to conservative. My friend is in a conservative-type plan. She does have some control how the money is managed. She doesn't have a good understanding of investing or how much money he needs. My friend is older but pretty health. Who knows how long she'll live. I assume stock funds are needed, but I don't know how much. She doesn't want to run out of money.

I can list the funds in the account if that will help.

Really good answer. If I may toss in a couple of possibly superfluous points: referring to your, "1)" A fund may change suddenly and without warning for various reasons; e.g. with all the rage about diversification, many funds are controlled by ONE individual whose investment formula may or may not be understood by those who might replace him; "2)" it's not hard to check the stocks held by each fund

- I haven't but they may hold many of the same stocks (or share the same 'approved universe'). Also, the turnover of 96% you mentioned is outrageous for anyone interested in conservative investment.(or sound investment as opposed to trading), and for the amounts involved short- term tax rates are meaningful subtractions.

Dave is asking all the right questions. The particular dollar amounts don't matter so much as the structure and goal of the property - for example, if it is a trust, then what matters is the terms of the trust and not (directly) what your friend's needs are (though the trust may be written in terms of those needs). If the portfolio allocation is driven by your friend's needs, then your friend has to provide some clue as to what will be needed (let the bank work with her on that, but it can't be a shot in the dark, because volatility risk needs to be balanced with risk of running out of money).

A 1% fee is high, especially for a portfolio so large, if it's being managed as a cookie-cutter "conservative portfolio" of mutual funds (as opposed to individual stocks and bonds). If the bank is providing other services, then the fee may may be in line, or even low.

The particular funds used don't matter nearly as much as the overall allocation - your question of whether 63/35 is reasonable. As a shot in the dark (meaning a totally uninformed allocation disregarding the individual situation), I'd say that this is a bit high on the stock side, but not outrageous. I might use a 50/50 mix; Vanguard's Target Retirement 2010 Fund (which it suggests for people aged 63-67, with 1 year to retirement) is about 50/50. (Your friend is already retired, but also at the low end of that age range.) T. Rowe Price's 2010 Retirement Fund, that it recommends for 63 year olds, is a 59/33/8 mix, not far from what your friend has.

Finally, regarding the losses - in the month of May (from close of market April 30th, to close of market May 28th), Laudus Int'l MarketMasters lost 10.6%; over the same month, Vanguard FTSE All World ex-US (a reasonable proxy for the entire international market) lost

10.2%. The performance of the Laudus fund, short term, was consistent with the market, and less than your figures seemed to suggest. It sounded like you were describing a 20%+ loss in this fund in May - Account A currently at $350K after a $28K loss; say it started at $400K and this fund was about 1/5 of that ($80K) and had an $18K loss.

Mark Freeland snipped-for-privacy@nyc.rr.com

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I feel better hearing that some of you feel my friend's portfolio did not go down an unreasonable amount.

Here is what is in my friends portfolio. I would think many would say it has too many funds. Do you need to know how much she has in each fund?

Taxable Bonds - 35% of portfolio * Pimco Total Return Fund PTTRX * Credit Suisse Comm Ret ST Co CRSOX * Ishares Tr Iboxx HY Corp Bd E T F HYG * American Centy Indl Bd Fds AIDIX * Ishares Barclays Aggregate E T F AGG

Stock Funds - 63% of portfolio * American Grw Fd of Amer F2 GFFFX * Eaton Vance Large Cap Val I EILVX * Ishares S&P Smallcap 600 Index E T F IJR * Laudus Intl Marketmasters Fd Select SWMIX * Pioneer Fund Cl Y PYODX * Rowe T Price Mid-Cap Growth Fd #64 RPMGX * Rowe T Price Mid-Cap Value Fd Inc TRMCX * T Rowe Price Sm Cap Val PRSVX

My friend does have some money in cash, and gets some additional money from another account.

Bill,

I have some familiarity with what you're talking about. I don't think I have read the book you mentioned, but I have read other things that I think agree with the points you are making. I use those guidelines in my own investing. Unlike my friend, I'm a ways off from retirement.

I have some understanding that many consider index funds best, of high expense ratios, and turnover rates. I feel a little overwhelmed trying to evaluate my friend's portfolio. It has thirteen funds in it. I have looked at Morningstar reports on some of the funds.

My friend allows me to talk to the bank directly. I can question them about the funds in the portfolio. But I don't feel knowledgeable enough to tell the bank: "You're doing this all wrong. Here is a list of funds you should buy". It's not my money. I don't want to tell my friend the wrong thing. I don't want her to run out of money.

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Consider having your friend find a fee-only financial planner or investment advisor who works by the hour. Such a person will have the least designs on taking the money under management (since, as you said, it has to stay with the bank for whatever reason), but such an investment advisor will, hopefully, be knowledgable and able, with your friend's permission, to discuss the portfolio directly with the bank.

Ask around, get some recommendations, but make sure the person you find is "fee-only". Not "fee-based". And check out the person's ADV forms (it may be found via the SEC's advisor search engine, even before your friend contacts such a person). The ADV forms will list information about the advisor's background and the advisor's billing practices.

I understand your concern about your friend running out of money. All of us who are retired and who depend in whole or in part on our investment portfolio have the same concern. There is no guarantee. Two things to do are:

1) Do not withdraw more than 3% of assets per year.

2) Minimize investment expenses to maximize returns.

Assuming your friend could live 20 years or more, inflation is a real concern. Therefore an allocation of 60% equities 40% fixed income is not unreasonable.

I agree that you should not try to tell the bank which funds to buy. However, there are some questions I would ask the bank.

1) Please provide a written explanation of all fees, commissions, discounts, payments or other consideration of any kind that the bank receives from any of the funds or fund managers that your friend's money is invested in. The answer should be that the bank does not receive any consideration of any kind from the funds. If they do receive any compensation there is a conflict of interest and the banks investment decisions are likely based on what is best for the bank, not what is best for your friend.

2) Categorize the funds they by asset class. By asset class I mean what combination of domestice or international, large cap or small cap, and value or growth each fund belongs to. Note that anyone reading your message could research the funds and categorize them if they have the time to do so but the bank should have that information at their finger tips.

3) Why are they using high expense actively managed funds? They should provide an explanation for any fund for which Morningstar shows expenses greater than 0.5%. If expenses can be reduced by 1% on a $500,000 portfolio that translates to an extra $416.66 each month in your friend's pocket.

When a bank invests a client's money in a load fund, who gets the load? The bank? A salesman who deals with the bank? Some combination? These things need investigation.

thirteen funds in

Bill's advise is very good, IMO. The basis for any stock fund is the companies selected. To evaluate a fund, look at the investment goals and objectives, then look at the companies held. The on-going concern concept is based on earnings. A fund's turnover is important. A high turnover a) makes it harder to discern what the fund is doing, b) pays short-term gains which are taxable as ordinary income.

What is a reasonable turnover rate?

Thanks to everyone for their advice.

has thirteen funds in

Turnover will (should) depend on the stated policies and objectives of the fund, but for the conservative management it sounds like you would prefer, no more that 15% - 20% annually would be appropriate. Ideally, one might expect 7% - 12%. The idea is that purchases are based on careful analysis, so sound companies with solid earnings are selected at or near their low prices, with no change in the reasons for buying them for many years. I would also set the long term capital gains distributions at a minimum 70% of total (excluding dividends), ideally above 90%. This also reduces the taxes due.

In markets that trend upwards for years at a time, you might expect very little turnover (below 5%). When markets get frothy, you might expect an unusually high turnover (30%, even 40%), but funds have some obligations to remain invested, so much of the change should be away from overpriced, and towards counter-cyclical stocks, with an increase in cash balances. There are also pressures on funds to "look good" and that can influence changes, but raises questions about what they did that they think "looks bad." When you get more than 50% turnover, regularly, a number of questions deserve to be answered. Bill mentioned the international fund he looked at had a 95% turnover. You really should check their goals and policies carefully, and compare their after-tax returns, and their weighting in 'your' portfolio, to other holdings. The bank will explain that some risk is appropriate to boost overall return.