Has your financial advisor contacted you lately? Although global stock markets (VT) have recovered from their earlier in the year losses, it could’ve revealed flaws with your investment portfolio’s design. Often, flaws that are camouflaged by rising markets are exposed and exploited in rocky markets.
Ultimately, advisors should take responsibility for the investment recommendations they make and the advice given should always conform to a person’s age, risk tolerance, and life circumstances. Sadly, some financial professionals – even those with years of experience and a handsome looking resume – don’t operate this way.
My latest Portfolio Report Card is for BR, a 79-year old widow from New Jersey, with a $1,585,000 investment account divided across an inherited IRA, family trust, and taxable brokerage account. She became concerned about her investments when her financial advisor abruptly resigned from her account and left her hanging.
After requesting a Report Card, BR informed me that generating income from her portfolio is the most crucial aspect of her investment plan. Nevertheless, she still described her investment strategy as the following: “Honestly, I leave it up to the advisor. I just need to pay off my mortgage, bills and my goal is to enjoy life without touching the principal.”
What kind of grade does BR’s investment portfolio get?
Cutting investment cost, commissions, and ongoing asset fees should be a priority for all investors. Why? Because the less you spend, the more you keep. How does BR do?
BR’s portfolio holds 17 ETFs, 6 individual stocks, and cash. Annual fund expenses on the ETFs range from 0.12% (low end) to 0.95% (high end) and the advisory fee of 0.95% pushes up the cost of this portfolio to just over $22,000 annually (including both fund and advisory fees).
The cost of BR’s portfolio is seven-times higher versus a blended benchmark of index ETFs matching her same asset mix.
Investment portfolios missing broad market exposure to the five major asset classes – stocks (SCHB), bonds (AGG), commodities (DBC), real estate (RWO), and cash – do not pass the diversification grade.
It’s nice to see that BR’s portfolio has exposure to US and international stocks (EFA), US real estate, bonds, commodities, and cash. However, most of the ETFs being used for exposure to these areas within her portfolio are narrowly focused or speculative funds that use leverage with long/short exposure.
A closer look at BR’s top 10 portfolio holdings also reveals that only one fund – the Vanguard REIT ETF (VNQ) – is really a core building block with broad exposure, while the remaining holdings are concentrated in non-core funds with a tactical flair. Her advisor has erringly built the core of BR’s portfolio using non-core assets. It’s faulty construction that’s akin to building a summer beach house in the Rocky Mountains.
BR’s overall asset mix is the following: 45.5% stocks, 7% bonds, 18% US real estate, 4.7% gold, and 24.8% cash. Although income and preserving capital is her main goal, her advisor has purchased ETFs that short stocks, bonds, and currencies and made them among her top holdings.
Another way to view BR’s portfolio is to ask, how would it perform during a bear market? A 20% to 40% market decline would subject her combined portfolios to significant potential market losses of $237,000 to $474,000. In other words, even with almost one-quarter of her portfolio in cash, she still wouldn’t be shielded from a severe setback.
The bulk of BR’s assets are held in a tax-deferred IRA ($1.3 million), however the remaining portion is invested in taxable accounts with dividend paying REITs like Annaly Capital Management and W.P. Carey as the main holdings. Why didn’t her advisor taken deliberate steps to minimize her tax liabilities by holding REITs inside her tax-deferred IRA?
BR’s portfolio could definitely use some smarter asset location and her advisor clearly never earned the 0.95% fee he’s been siphoning from her account.
Regardless of whether the stock market is up or down, your investment performance will either confirm or deny the architectural soundness of your portfolio’s design. Additionally, the attention you give – or fail to give – to cost, risk, diversification, and taxes has a direct influence on your bottom line results.
Over the past year, BR’s portfolio fell 2.9% (-$51,641) compared to a gain of +1.72% for the index benchmark matching this same asset mix. Put another way, she underperformed the benchmark by significant margin of 4.62%.
The Portfolio Final Grade
BR’s final Portfolio Report Card grade is “D” (poor). This means her portfolio scored poorly in all five grading categories and has major structural flaws.
A 20% to 40% market decline would inflict serious damage to her net worth and could force her to make uncomfortable lifestyle changes. Diversification is sloppy and omits core holdings with broad and low cost exposure to the major asset classes.
Moreover, her advisor incorrectly used non-core assets like long/short ETFs and sector commodities funds for her portfolio’s core instead of using broadly diversified building blocks. And now that he’s bailed on her, his mistakes have been compounded by a portfolio without a captain. Putting a 79-year old widow into fast moving tactical funds when her goal is simply to generate safe income is downright negligent.
Ron DeLegge is the Founder and Chief Portfolio Strategist at ETFguide. He’s inventor of the Portfolio Report Card which helps people to identify the strengths and weaknesses of their investment account, IRA, and 401(k) plan.
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