READY MONEY: INVESTMENT ODDS FAVOR BALANCED FUNDS
Yes! Ready Money Is Aladdin’s Lamp. — Lord Byron
Charlie doesn’t talk about investing anymore. Two years ago, it was a constant topic. Back then, he had just taken early retirement so he built a virtual trading room in his house. His television was tuned to CNBC and his computer was tied to his favorite electronic broker. He loved technology stocks. He really liked managing his money.
Today, things are different.
He has a money manager. He doesn’t talk about what happened. When the subject of investments comes up, he talks about his new part-time job. Charlie has acquired some serious humility.
Charlie is typical of millions of investors — a group that might be called The Recently Burned. They are surrendering their battered investments to professionals who promise to build disciplined, diversified portfolios that will minimize risk and maximize gain. Not only that, they will build portfolios with high alphas and low correlations between asset classes. If that fails to impress, they’ll make sure your portfolio gets a healthy dose of mean variance optimization — not the kind of thing you should try at home.
Some managers do it with mutual funds; some do it with collections of private managers. In the trade, they’re called “wrap accounts.” Most cost something north of 2 percent of your assets a year if you don’t negotiate a lower fee.
It’s also a booming business. According to Cerulli Associates, a Boston firm that researches the money management industry, assets in wrap accounts have quadrupled over the last six years.
There’s only one problem. The fees exceed the possible benefit.
Here’s the math. If you line up 100 fund managers who specialize in large capitalization stocks, the difference between the top and bottom performers tends to shrink as the investment period gets longer. At three years, the difference between the 25th percentile manager and the 50th percentile manager is 1.78 percent. At 10 or 15 years, it is about 1 percent. Over the long term, an additional 1 percent portfolio management fee will drop the equity portion of your portfolio’s performance about 25 percentile.
It’s worse with bonds. The difference between the 25th percentile and the 75th percentile is less than 1 percent after just 10 years, so a 1 percent management fee could take your bond return from the top 25 percent to the bottom 25 percent, all by itself. Apply the fee to a portfolio of stocks and bonds and the additional cost will drag performance down about 31 percentile. That’s a lot of drag.
Even so, wraps may still be a good choice compared to the chaos of home brew money management.
So consider a simple alternative. It’s called a balanced fund. If you had simply invested in the five largest balanced funds (American Funds Income A shares, Fidelity Asset Manager and Puritan, and Vanguard Asset Allocation and Wellington), your average performance over the last three, five, and 10 years would have been in the top 25 percent of all balanced funds, and your average cost would have been less than six-tenths of a percent.
The odds that a wrap manager will do better? You guessed it, about one in four.
Scott Burns (www.scottburns.com) has been a personal finance writer since 1977 and has been syndicated in newspapers across the United States since late 1980. Send your questions and comments about managing your wealth via e-mail to privateclubs@clubcorp.com.