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Outside the Box: The million-dollar decision under every investor’s control

For most of my adult life I’ve been doing my best to teach investors how to make the best choices without paying a professional adviser.

This is ironic for somebody who founded and ran an investment advisory firm for nearly 30 years. It’s even more ironic because I pay an adviser to help me with my own investments.

However, it’s undeniable that DIY investors can save a great deal of money. It might seem quite reasonable to pay 1% annually to an adviser — until you do the math.

We did some of the math for you, using the Merriman Education Foundation Lifetime Investment Calculator.

Assume that you retired in 1970 with $500,000 invested 60% in the S&P 500 index SPX, -0.34% and 40% in bond funds, taking out 4% of your portfolio value at the start of each year for 30 years. At the end of 1999, you would have withdrawn a total of $1.72 million. Plus, your portfolio would be worth $4.57 million.

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Now imagine the same assumptions — except reduce the returns to reflect a 1% annual fee paid to an adviser. In that case, your total withdrawals over 30 years would be $284,000 less. (No, that’s not a typo.) And your ending portfolio value, $3.49 million, would be reduced by more than $1 million.

By paying 1% to an adviser, you would have given up one-eighth (16.5%) of your retirement withdrawals plus nearly a quarter (23.7%) of what was left over for your heirs. Total cost: about $1.37 million.

In light of those numbers, a 1% annual fee might seem less innocuous. (You can see the details here.)

So if you are up to the challenge of being your own adviser, you can potentially save a ton of money.

But the job is full of daunting tasks. Here are eight of the most important ones.

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Choose your equity investments

I’m not talking about picking individual stocks. I’m talking about asset classes. For example U.S. stocks vs. international stocks, growth stocks vs. value stocks, large-cap stocks vs. small-cap stocks.

Here’s some guidance: An article I wrote last winter on the best asset classes for the long term.

Divide up your portfolio among your chosen asset classes

The article I just referenced suggests an approach I have been recommending for nearly 30 years. However, it requires investing in (and managing) 10 individual funds.

That’s too many for most people, and I often suggest an alternative: a four-fund portfolio that includes lots of diversification while significantly reducing the complications.

Determine how much risk you can handle

This topic is worth an entire book. Get this one right and you can have a relatively stress-free financial life. Get it wrong, and you can lose your peace of mind as well as a lot of money.

This is about allocating a percentage of your portfolio to bond funds. Stocks are the engine that moves you forward; bonds are the brakes that keep you from going off the rails.

Only an incompetent amateur adviser would skip this task, so don’t do that to yourself. Here’s an important article to help you think about this.

Plan to reduce your risk as you age

Typically, young investors should have most or all of their money in stock funds (the engine) instead of bond funds (the brakes). But as we get older, most of us will be more comfortable with a healthy dose of bond funds.

This change is best accomplished gradually over time, using what the industry calls a “glide path.”

Fortunately, this is easy to do if you invest in a target-date fund, which gradually makes the transition based on your projected year of retirement.

Here’s an article that digs into this topic.

Figure out when you can afford to retire

This is tricky, and it’s one of the places where a seasoned adviser can be very helpful. But a diligent DIYer can do it.

Start by determining how much retirement income you will need from your investments. This task will be simple for some people, more complex for others.

You’ll find the details of how to do it in a chapter of my 2012 book Financial Fitness Forever.

Plan for either fixed or variable withdrawals

With fixed withdrawals, you start your first year of retirement by taking out what you need. Then every year after that, regardless of what’s happening with your portfolio, withdraw the same amount, adjusted to reflect actual inflation.

On the plus side, this gives you enough to meet your needs. On the minus side, these fixed withdrawals can take a heavy toll on your investments if inflation is high or returns are low.

If you have enough saved, you’ll be much better off using variable withdrawals. Each year you take out a fixed percentage (for example 4%) of your portfolio’s value to cover your living expenses.

When returns have been high, this gives you a bit more to spend. When returns are low, you’ll have to tighten your belt.

Here’s an article about fixed withdrawals. And here’s one on variable withdrawals.  

Choose the best funds to populate your portfolio

This can be a daunting task. Online, you’ll find hundreds of suggested combinations.

Your best bet will be to stick with index funds, keeping your costs low, your turnover low, and your emotional involvement low. For mutual funds, check out these recommendations. If you prefer exchange-traded funds, here are recommendations for them as well.

Manage your emotions and stay the course

Though this is last on my list, it’s arguably the most important task of all. I’ve seen many times how easy it is to fail at this.

When your portfolio isn’t living up to your expectations, sticking with your plan can require enormous faith. This might be especially true if all the important decisions that make up that plan were made by an amateur (you, in other words).

Good advisers can easily earn their keep by getting you calmed down when the markets have you reeling. If you do this on your own and get it wrong, the ultimate price you pay could make the services of an adviser seem pretty cheap.

A final word

Even if you’re confident you can do all these tasks, there’s still an important reason to consider hiring a manager: So there’s someone who can take over for you when that becomes necessary, either for you or for a surviving spouse. As I mentioned above, I work with an adviser. This is one of the biggest reasons why.

For more on this topic, here’s a podcast I recently recorded: “The Only Way to Guarantee Your Fair Share of Stock Market Returns.”

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.

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