On January 11, 2013, Yahoo's Daily Ticker did an interview with Amanda Steinberg, founder and CEO of Daily Worth. The piece was entitled: Why You Need to Know More Than Your Financial Advisor. While some of the advice was helpful, most of it was just wrong.
Steinberg correctly urges investors to understand the fees they are being charged. In addition to advisory fees, she states that "certain" ETFs and mutual funds "might" have additional fees. The reality is that almost all ETFs and mutual funds charge a management fee called an "expense ratio". What's important to remember is that the expense ratios of ETFs and index funds are significantly lower than those charged by actively managed funds (where the fund manager attempts to beat a designated benchmark). Steinberg should be cautioning her readers and viewers against buying actively managed funds and directing them to the research indicating that expense ratios are the best predictor of performance of mutual funds.
Steinberg's train goes off the rails with her recommendation that individuals take 5 percent of their portfolios and invest them in "index funds and securities." She believes you can measure the results of this portfolio "as a baseline relative to what your financial adviser is doing for you."
Investing in index funds is admirable. Picking stocks is very risky business. There is ample research indicating that those who pick stock winners are lucky and not skillful. If investors find it fun to engage in this activity, they should pursue it, but keep it to a small portion of the portfolio and not count on it being there down the road. After all, it is more akin to gambling than investing.
Contrary to Steinberg's advice, you cannot use the results of your self-managed portfolio as a basis against which you measure how your adviser is performing. That would be like measuring the speed of a bicycle against a jet plane. Comparisons of portfolios are only meaningful when the risk of both portfolios is the same. If your self-managed portfolio is invested 100 percent in stocks during a bull market, and your adviser is managing a portfolio of 60 percent stocks and 40 percent bonds, it's likely your returns will be higher, but that doesn't mean you are a better portfolio manager than your adviser.
Steinberg compounds this error by advising investors to ask their adviser how their portfolio is doing "relative to the S&P." The only time you should do that is when you have a portfolio with the same risk characteristics as that index. What if your portfolio is globally diversified (as it should be) and includes bonds, international stocks, and other stock asset classes that are not part of the S&P 500 index? A comparison of the results of your portfolio to the S&P 500 would be both inaccurate and misleading.
I am a big advocate of educating investors. However, those who hold themselves out as financial "experts" have a special duty to provide advice grounded in sound principles of finance. Steinberg's views fall far short of this standard.
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now, was published on Dec. 31, 2012.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information, and content on this blog is for information purposes only and should not be construed as an offer of advisory services.