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Investing Blog Roundup: Finding Good Financial Advice, at a Fair Price

How do I find a financial advisor? How much should financial planning services cost? How do I evaluate financial advisor candidates?

These and other similar questions come up a lot in my email inbox.

Jim Dahle recently provided a balanced take on the topic of finding/evaluating an advisor.

From the article:

“The rule of thumb is that high-quality financial advice costs a four-figure amount per year, ie, between $1,000 and $10,000. If you are paying more than $10,000 per year, you can almost surely get the same (or better) advice and service for less money. If you are paying less than $1,000 per year, you are unlikely to actually be receiving high-quality, personalized advice.”

I’ve never heard such a rule of thumb before, but I think it’s pretty good — not perfect, but helpful in most cases.

Other Recommended Reading

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Vanguard’s Upcoming “Digital Advisor” Program

In the last couple of weeks several readers have requested that I discuss Vanguard’s upcoming Digital Advisor program.

So far, we don’t really have any information other than what is included in the brochure Vanguard filed with the SEC with regard to the program.

As far as what the program is, it looks like a standard robo-advisor platform, which in this case implements portfolios consisting of the ETF versions of Vanguard’s four “total market” funds (i.e., Vanguard Total Stock Market ETF, Vanguard Total International Stock ETF, Vanguard Total Bond Market ETF, and Vanguard Total International Bond ETF).

The program has a 0.20% all-in cost (i.e., advisory fee + cost of underlying ETFs) regardless of what allocation you have, which means that the advisory fee is roughly 0.15%.

Relative to the existing Vanguard Personal Advisor Services platform, noteworthy differences are:

  • It costs about half as much,
  • It’s robo-only (no human advisor), and
  • It has a smaller account minimum ($3,000 instead of $50,000).

In terms of the underlying holdings, it’s super similar to Vanguard’s LifeStrategy or Target Retirement funds. It would be slightly more expensive than such a fund. (The difference in cost would grow if the LifeStrategy and/or Target Retirement funds eventually get less expensive due to switching to underlying ETFs or Admiral Shares instead of Investor Share versions of index funds.)

What will the Digital Advisor program offer that one of those all-in-one funds doesn’t offer?

The brochure includes the following statement:

“When requesting that Digital Advisor manage your enrolled accounts, you’ll have the ability to impose reasonable restrictions on the management of your Portfolio by personalizing the inputs into your retirement accumulation goal beyond standardized defaults.”

It’s hard to tell without seeing the interface and without anybody actually having gone through the program, but the above makes it sound to me like there will be some option to customize the allocation among those 4 funds somewhat. (For example, I personally would appreciate the option to reduce the allocation to the international bond fund. It sounds like that would probably be a choice, but it’s not super explicit.)

One thing that the new program will offer is implementation of a basic asset location plan. The brochure includes the following statement:

“For Portfolios containing both taxable and tax-advantaged accounts, our investment strategy will aim to optimize the tax efficiency of the Portfolio by recommending or allocating investments strategically among taxable and tax-advantaged accounts. The objective of this ‘asset location’ approach is to hold relatively tax-efficient investments, such as broad-market stock index products, in taxable accounts while keeping relatively tax-inefficient investments, such as taxable bonds, in tax-advantaged accounts.”

So based on the incomplete information available at this time, it largely strikes me as “LifeStrategy/Target Retirement replacement for people with assets in taxable accounts” or “LifeStrategy/Target Retirement replacement for people who want some allocation among those 4 underlying holdings that is not available via those all-in-one funds.”

But I suppose we’ll learn more once the program is actually available.

Investing Blog Roundup: Problematic Probability of Ruin

There are plenty of ways to evaluate a retirement plan. (For instance, here’s a paper from Wade Pfau, Joe Tomlinson, and Steve Vernon discussing 8 different metrics for evaluating retirement spending/portfolio strategies.) By far the most common though is “probability of running out of money.”

But as Dirk Cotton discusses in a recent article, that metric leaves out a ton of useful information. In addition, it’s questionable how accurate such a metric can be, for any strategy that includes stocks.

Other Recommended Reading

Thanks for reading!

Can a Year of Low Earnings Reduce My Social Security Benefit?

A reader writes in, asking:

“I’m in the not-quite-retired-but-probably-could-afford-to-if-I-wanted-to stage of my career. I am pondering many options, including cold-turkey retirement, switching to fewer days per week, or retiring but starting a new type of work that I hope would be more fun on a daily basis. One concern I have about the last two options is that they will result in one or more years of lower earnings at the end of my career, and I have heard that could reduce my social security retirement amount. Is that true?”

Short answer: no, that’s not true.

Many pensions are based on things like “average of last 5 years of earnings.” For pensions like that, yes, a year of low earnings at the end of one’s career could result in a smaller pension.

But that’s not how Social Security works. Your Social Security retirement benefit is based on your 35 highest years of earnings (after adjusting years prior to age 60 for wage inflation). If you have a new year of low earnings, worst-case scenario is that it isn’t one of your 35 highest and it therefore is simply not included in the calculation. In other words, that year of earnings wouldn’t reduce your benefit — it just wouldn’t increase it, as an additional year of high earnings might.

However, a year of low earnings could cause the benefit estimates on your Social Security statement to go down. Similarly, a year of low earnings could cause your actual benefit to be lower than the benefit estimate that you are seeing on your statement.

The key point here is that the benefit figures that appear on your statement are estimates. And those estimates include a projection about future earnings. Specifically, the estimates assume that you continue earning — at the same earnings level as your most recent earnings year for which the SSA has data — until you retire and file for benefits (the estimated figures on the statement assume that those two things will happen simultaneously*).

So:

  1. If you have a year of earnings that was lower than your prior year, once your benefit estimate reflects the new lower year of earnings (and therefore projects that lower earnings level forward) it could result in a lower estimate, and
  2. If your actual earnings turn out to be lower than the assumed/projected earnings baked into the estimated benefit figures, your actual benefit could turn out to be lower than the estimated benefit.

But again, an additional year of low earnings will not reduce your actual benefit. Worst-case scenario is that a year of low earnings will have no effect on your actual benefit (i.e., will not increase it).

*This article explains how to use the SSA’s calculators to calculate what your benefit would be if you retire at a different age than the age at which you file for benefits.

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Investing Blog Roundup: Interest Rates and Social Security

From time to time I receive emails from people using the Open Social Security calculator who want to know: why is it giving me a different answer than it gave me last time I ran it?

The answer (unless you’re changing inputs on your own) is usually interest rates. By default, the calculator automatically pulls in the yield on 20-year TIPS to use as the discount rate. And that yield changes over time. For instance it was 1.07% at the beginning of this year, fell to as low as 0.07% in August, and is now back up to 0.41% as of this writing.

Point being: claiming Social Security early (in order to keep a larger portion of your portfolio invested) becomes more/less attractive as interest rates rise/fall. For those who wish to experiment with this input in the calculator, you can check the box for “advanced options” at the top of the page and adjust the discount rate for yourself to see how the output changes.

Recommended Reading

Thanks for reading!

Dividend Reinvestment FAQs

I thought I’d do something different with today’s article. Below are a few questions — from different readers — about various aspects of reinvesting dividends. None of them required a long enough answer to constitute its own article, but the topics in question are likely to be of interest to other readers.

“I’ve read that from 1960 until now, 82% of the stock market’s overall return is from reinvesting dividends. But I’ve also seen that dividends are usually only 2-3% in a given year, whereas the market’s overall return might be something closer to 8%. I guess what I’m asking is why are dividends so much more important than the increasing price, even though they are a small part of the return?”

It’s not that the dividends are more important than the price appreciation. It’s simply that they are a significant part of the return, and leaving off a significant part of the return dramatically reduces the overall accumulation over an extended period. (This is the same reason that mutual fund expense ratios are super important.)

The longer the period in question, the more pronounced this effect. For example, a $1 initial investment that grows at 8% per year for 75 years will come out to about $321. Reduce the return to 7% instead, and the final result is just $160. In other words, reducing the return by one eighth cut the final value by half. If you instead reduce the return from 8% to 6%, you end up with just $79 — a one-quarter reduction in return reduced the final value by more than three quarters.

That’s why when you read about statistics regarding the importance of dividends over several decades, you see very pronounced effects. Any change to the rate of return will have a magnified impact on the ending value. The effect is smaller if we look at periods that are shorter but still significant over a person’s lifetime (e.g., 20 years).

To reiterate, dividends are important, because they are a significant part of the overall return. But the idea that they are far more important than the price appreciation is simply a misunderstanding of the math involved.

“Why does the price of a mutual fund fall when it pays a dividend?”

In short, the price falls because the fund has less assets, which means it’s less valuable. (The same thing happens with individual stocks, by the way.)

For example, imagine that a fund has a net asset value (NAV) of $25 per share on a given day, made up of $24 worth of various stocks holdings and $1 of cash. Then the fund declares a $1 cash dividend.

Anybody who buys the fund before the ex-dividend date will essentially be getting $24 worth of stocks and $1 of cash. Anybody who buys after the ex-dividend date will be getting just the $24 worth of stocks. Point being: the price should fall by $1 on the ex-dividend date. (Of course in the real world it’s messier than that, because the prices of the various underlying stocks would also be moving around from one day to the next.)

To be clear, the fact that the price falls on the ex-dividend date doesn’t mean that you lose something when your fund declares a dividend. The price falls, but you now have an equivalent amount of cash in your brokerage account. (Or, if you reinvest the dividend, you’re in exactly the same place as before, tax considerations notwithstanding.)

“Should I set my mutual fund to automatically reinvest dividends?”

Maybe.

Having dividends automatically reinvested means that your money begins to earn a return sooner, which is a good thing.

But, if the account in question is a taxable account, it also means that there’s more tracking to be done, because you’ll have a greater number of dates and prices at which you purchased shares. But if you aren’t tracking your cost basis yourself anyway (e.g., you’re using the “average cost” method, and you are relying on your brokerage firm to calculate such for you), then the additional complexity doesn’t much matter. (To be clear though, I would encourage you to keep your own cost basis records, rather than completely relying on another party.)

You should also be aware that automatic reinvesting of dividends could result in a wash sale if you sell the investment in question at what would otherwise be a loss. Generally, this would not be a major reason not to reinvest dividends, as the effect would usually be small. But it’s something to be aware of so that you can report your taxes appropriately.

“How do I calculate the gain or loss on a sale of a mutual fund when I have had dividends and capital gains reinvested? Last year I invested $40,000 in a mutual fund, and it was worth about $40,500 at the end of the year. My dividends and taxable gains for that year, all of which were reinvested, were about $1,700 according to my online statements. Let’s say my fund’s value is $40,500 when I sell it this year. What would be my gain or loss?”

Because you have the account set to reinvest dividends and capital gains, you actually purchased $1,700 worth of shares over the course of last year. So your total basis at the end of the year was $41,700.

So if at the beginning of this year (i.e., before any new money gets invested or distributions get reinvested) you had sold all of the shares for a total of $40,500, then you would have a capital loss of $1,200 (i.e., $40,500 realized on the sale, minus $41,700 cost basis).

If further dividends/capital gains had been reinvested this year before the sale, those would be added to your cost basis as well.

Whether or not you could actually claim this loss would depend on whether or not it’s a wash sale — which it could be, if you own other shares of this same investment (or something else that is “substantially identical”) in another account.

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My new Social Security calculator: Open Social Security