Many investors believe that all DFA advisors will provide equal quality advice, have an equal understanding of the principles and strategies of Dimensional Fund Advisors and will provide equal reporting and service in the future, even though they have different fee schedules.
This would assume a form of a free lunch if it were true.
Investors are encouraged to carefully consider their decision
as to whom they select to manage their their life savings, because not all
DFA advisors provide equal expected returns, net of all fees, portfolio risk and advisor risk. Especially when you consider the risk you take when entrusting your hard earned money to the lowest bidder of investment advice. There is a fair price for quality advice.
The following exchange between a low cost advisor and his client
occurred when the client discovered the high cost he had paid
for going with a low-cost advisor. The client stated that "he
would not stay there, even if it were free."
(Dated Feb. 1, 2005):
..."I need more
than a few sentences in terms of reporting and analysis
of each quarter's activity. ..
Your bearish sentiment
about the US economy has led to a market-timing strategy
that's hard to reconcile with my belief in passive index
investing.
I realize that you were trying to
protect me by recommending an extremely defensive allocation
of 30 [stock]/70 [fixed income].
Several IA's
[Investment Advisors] have made the point that my modest
equity allocation has cost me well over $1 million of
lost opportunity.
This is terribly frustrating
since, as you know, big upward moves come in a relatively
small number of days and if you're not in the market,
you miss out on them." ... Perhaps your worst fears
about the economy will come to pass and I'll regret having a
larger equity allocation." |
(Dated Feb. 2, 2005):
"You're betting against some
of the brightest and richest minds in the business,
Buffet, Templeton, Gross, Grantham, Roach.
The weakness of the DFA models is
the assumption that the numbers are constants; they
are not. [DFA has never made
such claims.*] LTCM's [Long
Term Capital Management's*] 1998 blow-up illustrated
that similar models [to those of DFA] can completely
fail; one of their [LTCM] Nobels is on DFA's board.
I've made a difficult decision. I'm
not going to tell clients the risk anymore because it's
not good for my business...
I'll just give them the DFA numbers
and tell them there's no guarantee of a repeat but that's
the best we have, so don't underweight equities. It's
not my money."
* added comments
|
This cheap advisor appeared to be
negative on future stock returns and questioned DFA’s model
for capturing the returns of globally diversified capitalism. This
type of sentiment runs counter to the basic principles of investing
in DFA funds in the first place. DFA’s principles articulate
that no one can forecast short term market returns. From
the time of this email in Feb. 2005 to Aug 2006, the S&P 500
was up 10.36%, which is virtually same return as the 80 year annualized
average of 10.27%, for the period ending Dec. 2006. Bad advice
can be very costly.
This
an exact quote from a cheap advisor's web page titled "ASSET
ALLOCATION FOR BEARS" which indicates the lack of understanding
of market timing and index investing, "We
cannot know that a long-term secular bear market is in place
until we're well into it. In late 2002 I wrote that we might
be enmeshed in the worst bear market since the 1930's. It
had all the characteristics of a long-term secular bear
market. Percentage declines on the major indexes were the
worst since the Great Depression."
This is the type of comments that are proof of
a lack of understanding of equity markets, especially since
IFA Index Portfolio was up 51.6% in 2003 and
the clients of this low-cost advisor probably missed out
on most of that return.
A great example of how expensive bad advice can be is to look
at the returns of different index portfolios in 2003. If an
advisor does not properly advise clients on the correct
level of risk and puts them in an index portfolio equivalent portfolio
to IFA Index Portfolio 30, they would have earned 18.89% return.
If the client had a risk capacity of 60 and had invested in
a more appropriate Index Portfolio 60, they would have earned
32.01%. That is a 13.12% difference in return. A low
cost advisor can not lower his fee enough to make up for bad
advice. The client from the above email had this situation
with a $7 Million portfolio, which created a $924,000 gap in
one year of returns between good advice and cheap advice.
There ain't no free lunch -- even among DFA advisor
It's
Unwise to pay too much…
But it's worse to pay too little.
When you pay too much, you lose a
little money - that is all.
When you pay too little,
you sometimes lose [a lot, or even] everything, because
the thing you bought was incapable of doing the thing
it was bought to do.
The common law of business
balance prohibits paying a little and getting a lot -
- it can't be done.
If
you deal with the lowest bidder, it is well to add something
[to the bid] for the risk you run. [In
other words, the increased risk is equal to a higher
cost, that is not recognized in the price.*]
And
if you do that [add the
risk of not getting what you should to the price*], you
will have enough to pay for something better.
- John Ruskin (1819-1900)
*added comments
|
Before you make a decision about using any advisor, you should CAREFULLY
investigate the differences between fees charged and services provided. It is
unwise to pay too much, but there are potential hazards for paying too little.
IFA knows that clients expect plenty for the fees they pay. Value-added benefits
for a fair fee about 1% for the first $500,000 and a tiered discount on larger
assets under management should include a well-run office space with a professional
and qualified staff that will
- efficiently executes and maintains the integrity
of risk-appropriate investing that incorporates the sound
research behind the Fama/French models
- ensures timely, accurate buys, rebalances,
account monitoring, and reporting
- maintains sufficient errors and omissions
insurance to protect your assets
You get what you pay for with IFA and
other quality and fairly priced DFA approved advisors. In
the end, the clients of “cheap” advisors will
most likely pay dearly for the advisors’ underestimating
the costs of properly operating their business.
A previous bank president with a $4 million
account was considering obtaining advice from a cheap advisor,
but thought he should visit the office of the advisor first.
After his visit to the advisor’s home, he was sufficiently
concerned about the setting that he decided not to go the cheap
route and to pay a fair price for his advice.
If low cost advisors don't have a "real" office, they
may skimp on other essentials such as proper security,
cheap software, computer backups, E&O (Errors
and Omissions) insurance, written policies and procedures,
and other important features that indicate a commitment
of a "real" business, not an experiment. IFA
has 12 advisors that serve their clients and serve as
backup to other advisors, plus additional staff to assist
in prompt customer service, trading, opening of accounts
and money transfers. Don't ASSUME that you won't
have problems if you don't have that support. An error
could make up several years of advisor fees. Despite what
they may tell you, errors happen. Schwab has a Trade Error
Department whose only job is to correct and bill investment
advisors for such errors when the error goes to the negative.
Many advisors like to put a "spin" on
the DFA approach. They attempt to convince investors that they "have
a better solution" than DFA. They use strategies that
include "market timing", or fund substitutions. Such
strategies should be skeptically analyzed, with insistence on
proof that they are actually beneficial to you.
Index Funds Advisors is a "pure" DFA approach that
follows DFA strategies without attempt to do it
better than Fama and French. We simply try to educate our
clients and prospects and provide a solid platform for successful
investing. With our extensive web site and Mark Hebner's book,
there should be no risk as to our understanding of how capital
markets work. Therefore, IFA may be considered your minimum
risk advisor.
Think twice
before adding an additional layers of risk to your portfolio
in the form of higher "investment advisor risk." The
stock market has plenty of risk to manage on its own, without
adding advisor risk.
In summary, a client of a cheap DFA advisor should lower the risk exposure of their index portfolio by at least 15 points, adjusting downward for the cheap advisor risk exposure, for example, from an IFA Portfolio 75 to a 60. This will equalize the total risk exposure to that of an IFA client, with minimal advisor risk. When you do that, you have a 1.06% lower expected return from the cheap advisor, plus whatever fee savings, and you no longer have a good deal (based on 50 year annualized returns ending 2006). In other words, does a lower fee exceed the 1.06% reduction in expected return of a risk reduced index portfolio? Is there really an expected savings? Is there really a free lunch?
To learn more about Index Funds Advisors
and a Fair Price for Advice, visit ifa.com.
