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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.

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