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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.

Working as an Advisor at Edward Jones: Ethical Qualms

A reader writes in, asking:

“You have mentioned a few times that you were a financial advisor with Edward Jones early in your career. My oldest child will be graduating in May next year, and a local Jones advisor/manager is trying to recruit her to come on board as an advisor after graduation.

I am aware that they still use the old-school commission type of compensation for their advisors, which is often not the best from the client’s point of view. But what I am most interested in knowing is whether you were ever asked to do anything that felt like it was against the client’s interests, or were you generally free to operate as you saw fit, according to your own ethics and best practices.”

A relevant point here is that I worked at Edward Jones for just under a year, and I was 21-22 at the time. So while there is still quite a bit about financial planning that I don’t know, it’s safe to say that I knew much less back then. Point being, there were an assortment of things that they told us to do, which I now realize were less than ideal, but which I just accepted at the time because I didn’t yet know any better.

But, yes, there was one instance that really made me uncomfortable, even with my very limited knowledge.

Immediately after we got our licenses, we were brought back in for a week of sales training at the home office. During that week, two of the days were spent making phone calls to prospective clients whom we had met over the last few months, in order to pitch them an investment product.

We didn’t get to choose the product. On the first day we had to pitch an individual bond. We could choose between a corporate bond (one from General Electric) or an AAA-rated muni bond from the state in which the client lived. I went with the muni bond. I knew it wouldn’t be ideal for plenty of the people I was calling (after all, I had no idea about their tax situation or about the rest of their portfolio), but at least it wasn’t likely to blow up on them.

On the following day, we had to pitch an individual stock. Even back then, I wasn’t at all on board with the idea of selling somebody an individual stock, especially while knowing almost nothing about the person in question. If they put, say, $20,000 into this stock, is that a trivial amount for them? Or are they going to be in a serious predicament if the stock goes south?

In addition, we had a supervisor listening in on the phone call, without the prospect’s knowledge. And we were in a loud room, full of people making similar calls. It was about as far as away from financial planning as you can get.

I remember making a point of calling all my worst prospects (that is, people who I knew were very unlikely to become clients), calling the same numbers repeatedly over the course of the day (i.e., calling people who weren’t home 20 minutes ago, in the hope that that would still not be home now), and intentionally flubbing my sales pitch when I did actually get a hold of somebody.

My plan was to just make it through those two days, then go back to my office in Chicago and run things in a way with which I was more comfortable: constructing diversified mutual fund portfolios. (In fact, this course of action was explicitly recommended to me by the manager in the Chicago region where I was working. Even as a long-term Edward Jones broker — somebody very comfortable with a sales/commission type of advisory role — he thought that the home office’s boiler room-style sales training was terrible for both clients and advisors.)

This was ~13 years ago, so I don’t know in what ways their training process has or hasn’t changed since then. Nonetheless, Edward Jones’ business model is still based on fundamental conflicts of interest between the client and the advisor, and I would not recommend it as a place to work as an advisor (nor as a place to invest as a client).

If at all possible, for a recent graduate interested in working in financial planning, I would instead suggest Michael Kitces’ approach of trying to get a position not as a financial advisor but rather in an operations/support role at a financial advisory firm with a good reputation and client-centric business model. Any place that will hire people as full-fledged advisors right out of undergrad (and with no certifications) is almost certainly going to be employing those people in a product-focused sales role rather than actual financial planning.

Brief tangent: as it happens, the two stocks were Coca Cola and Bank of America. This was in April of 2006. Coca Cola has done great over the period — considerably outperforming the market overall. Bank of America, on the other hand, is down roughly 20% over the entire period, and it had a truly harrowing crash during the 2008-2009 bear market — at one point having declined by more than 90% (!!) from the April 2006 purchase price. Good example of the risk of individual stocks.

Using an Advisor or a Target Retirement Fund

A reader writes in, asking:

“Would the average investor be better off using the services of a financial advisor or just buying and holding a Vanguard Target Retirement Fund in their IRA and their 401K?”

Target-date fund by a mile. Not even close.

To be clear though, that answer is the result of the way the question has been phrased.

First, Option #1 — buying and holding target-date funds — is actually quite a good plan, in most cases. It’s almost a best-case scenario for a DIY investor. The average DIY investor is not likely to do as well as this plan (either because they would construct a worse portfolio than they’d have with the target-date fund(s) or because they would not properly execute the “and hold” part of the plan).

Second, Option #2 — using a financial advisor — has a questionable outcome. The average investor is likely to end up using a typical financial advisor. And the typical financial advisor is poorly informed and up to his eyeballs in conflicts of interest.

For every well informed, fee-only financial planner who charges a reasonable price, there’s another advisor who’s going to tell the client to stop contributing to their Roth IRA and 401(k) so that they can throw money into a fixed-indexed annuity or cash-value life insurance policy when there’s no need for life insurance.

The typical/median/”middle of the road” advisor is the Edward Jones sort of guy — no real experience in broader financial planning and probably just going to sell the client a portfolio of reasonably diversified yet semi-expensive actively managed funds.

Relative to the “buy and hold target-date funds” plan, an investor using a middle-of-the-road advisor will end up with a portfolio that’s a) considerably more expensive when considering all the applicable costs, b) no better diversified (and possibly worse), and c) no better allocated. And to the extent that the investor receives any advice other than portfolio recommendations (e.g., incidental tax planning advice), it’s going to be questionable at best.

But good advisors are out there. And many investors (most, even) would benefit from using them, because:

  • Most people taking a DIY approach will not do as well as the DIY approach outlined above, and
  • Most people could use financial planning advice with regard to topics other than just their portfolio.

Evaluating a Financial Advisor’s Client Investment Performance

A reader writes in, asking:

“How can you measure, and verify, a financial adviser’s performance for the sake of comparing one prospective adviser to another?”

While this is a common question for people to ask, it’s not really a useful way to evaluate a financial advisor — for a few reasons.

First, an advisor doesn’t recommend the same portfolio to everybody. The investment portfolio that is appropriate for you as a client may be wholly inappropriate for another client with very different circumstances.

If an advisor or advisory firm were to calculate something like the average annualized return earned by their clients over a given period, that figure wouldn’t provide a meaningful point of comparison to another advisor’s such figure. For example, if one advisor has a clientele that is primarily middle class retirees, while another advisor’s clientele is primarily super-high-earners in their 30s or 40s, the clients of the first advisor would probably have, on average, lower returns over the last several years than clients of the second advisor — and that would simply be the result of the first advisor recommending appropriately low-risk portfolios for his/her clients.

In short, there’s no single figure that can be calculated to meaningfully measure how well the investment recommendations of a given financial advisor have performed over a given period.

Second, an advisor shouldn’t really be trying to do anything clever with respect to client portfolios. If an advisor is putting together a portfolio for you, a simple, boring portfolio of index funds/ETFs that approximately match the market’s return is your best bet. Intentionally seeking out an advisor who shows you a backtested, market-beating portfolio is setting yourself up for disappointment.

Finally, an advisor who engages in actual financial planning does a whole lot more than just make investment recommendations for clients.

A financial planner can also provide advice about tax planning or estate planning. They can help you evaluate your insurance coverage to see if there’s anything important you have missed (e.g., disability insurance). They can help with Social Security planning, and retirement planning in general. They can provide assistance with budgeting if that’s something you struggle with. They can provide advice with regard to your employee benefit options (e.g., help determine which health insurance is the best fit for your family).

And frankly, investment management is quickly becoming the least valuable part of financial planning. While there are still plenty of people whose investment performance would be improved by working with a financial advisor, the list of tools available for DIY investors to create a low-maintenance portfolio has grown dramatically over the last decade. Investors can now choose from Vanguard’s LifeStrategy funds, low-cost indexed target retirement funds at various providers, a smorgasbord of total market index funds/ETFs, or low-cost services like Betterment or Vanguard Personal Advisor Services.

Should Financial Advisors Be Fiduciaries?

A reader writes, asking:

“Do you think that a financial advisor should be a fiduciary? I’ve seen that discussed elsewhere, but never on your blog.”

Well, that depends on exactly what you mean.

If you’re in the market for a financial advisor, and you’re wondering whether you should use one who is a fiduciary (i.e., one who has a legal duty to put his/her client’s interests first) or one who is not, my answer would be, “Yes, use an advisory who has a fiduciary duty to you.”

This is a bit of an oversimplification, but in general:

  • Registered investment advisers (RIAs) and representatives thereof do owe a fiduciary duty to clients.
  • Insurance agents and stockbrokers do not owe a fiduciary duty to clients.

In the case of insurance agents and stockbrokers, they earn their pay by selling you specific products, which tends to result in biased advice. (This is not to say that RIAs are without their biases. Even fee-only RIAs have conflicts of interest, but I think they are at least somewhat less significant than the conflicts of interest faced by brokers and insurance agents.)

On the other hand, if you’re asking whether I think all financial advisors should be fiduciaries — a question which has been the subject of a great deal of debate within the industry over the last several years — I don’t have any strong opinions. I think it’s probably a good idea. (After all, why shouldn’t somebody who calls himself/herself a financial advisor be legally required to put clients’ interests first?) But, frankly, I’m not optimistic that such a change would have a large positive impact on the industry.

As it is, there are countless RIAs (who do have a fiduciary duty) who do all sorts of things that, in my opinion, clearly show they’re putting their own interests ahead of their clients’ interests. Yet, regulators don’t seem to have any problem with it.

For instance, many RIAs charge in excess of 1% per year to do nothing but passive portfolio management. At the same time, at Vanguard, you can get similar portfolio management, plus a basic financial plan, plus access to a CFP for 0.3% per year. The idea that the advisor charging more than three times as much for a lower level of service is somehow putting his/her clients’ interest first is laughable, given that there is such an obviously-better option for the investor. And yet, industry regulators have no problem with this — it is apparently not considered a breach of fiduciary duty.

And that’s not even remotely the worst of it. There are RIAs who charge high annual fees while also using expensive actively managed funds. There are RIAs who charge high annual fees while rapidly trading concentrated portfolios of individual stocks — or engaging in any number of other poorly-researched investment strategies. And, in the overwhelming majority of cases, such activities are not considered to be a breach of fiduciary duty.

In other words, if you’re going to use an advisor, yes, you should probably use one who has a fiduciary duty to you. But the sole fact that an advisor has a fiduciary duty does not ensure that he/she will always do what’s best for clients.

Do I Need a CFP, a CPA, or Both?

A reader writes in, asking:

“I’m looking for a ‘fee only’ professional who can take care of everything including tax returns, tax planning, financial planning, and handling the portfolio. I’m getting to the point where I no longer want the hassle, and my wife won’t want to handle it at all once I’m gone. Does such a person exist? Would I be better off looking among CPAs or CFPs?”

Let’s tackle the question of certifications first, since it’s relevant for anybody seeking an advisor, then we’ll move on to whether it makes sense to use a single person for all of the services desired.

Which Certification is More Relevant?

The sections of the CPA exam are:

  • Financial Accounting and Reporting (dealing with, for example, the statements that publicly traded companies must provide to shareholders),
  • Auditing and Attestation,
  • Regulation (dealing with individual taxation, business taxation, and business law), and
  • Business Environment (a catch-all category for other business topics such as economics, operations, finance, and information systems).

And the topics covered by the CFP exam are:

  • General Principles of Financial Planning,
  • Insurance Planning,
  • Investment Planning,
  • Income Tax Planning,
  • Retirement Planning,
  • Estate Planning,
  • Interpersonal Communication, and
  • Professional Conduct and Fiduciary Responsibility.

As you can see, the CFP exam is definitely tailored more precisely to personal finance than the CPA exam is.

However, there are two important caveats to note here.

First, there’s an additional, lesser-known credential that some CPAs go on to earn: Personal Financial Specialist (PFS). The PFS curriculum is very similar to the CFP curriculum, as are the topics covered on the exam.

Second, it would be rare to find any professional who is truly an expert in each of the topics covered by the exam for their certification. As you might expect, a professional’s expertise is going to depend much more on what field they work in than on what certification(s) they have. To use myself as an example, despite being a CPA, I know next to nothing about auditing, because I have never worked in that field and because my exam on the topic was approximately 4 years ago, meaning I’m well on my way to forgetting what little I once did know.

In summary, if you’re looking for a very comprehensive financial planner/professional, a CFP or somebody with the CPA and PFS certifications is likely to be your best bet. However, a person’s expertise will depend at least as much on their experience as on their certifications.

Is One Professional Really a Good Idea?

It’s easy to find a tax preparer who also does financial planning. Alternatively, it’s easy to find a portfolio manager who also does financial planning. But somebody who does tax preparation, financial planning, and portfolio management would be pretty rare. (And frankly, that makes sense. Trying to become an expert in all three professions would be exceedingly difficult.)

The most common solution would be to use two separate professionals: a tax preparer and a financial planner/portfolio manager. (In some cases, you may find it convenient to find a firm that has both types of professionals.)

Alternatively, you may not even need to pay a professional, per se, for portfolio management. Developments in the last few years — specifically, the rise of all-in-one funds and so-called “robo-advisors” — have made it clear that portfolio management is a commodity service, the cost of which is rapidly declining (and even approaching zero).

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