Edelman Financial: Bigger Isn’t Necessarily Better

Because Edelman Financial Services is opening six offices in the New York/ New Jersey area, I accepted an invitation to attend a seminar by Ric Edelman, the well-known author, radio host and investment manager.  The talk was held at the luxurious Hilton Hotel in nearby Short Hills last week.

Here is my review.  As a public speaker, I gave him an A+.  He was entertaining and informative, and offered a very clear piece of advice: Buy-and-hold a diversified portfolio of low-cost institutional mutual funds. Certainly, I would recommend his firm over a broker from Ameriprise, Smith Barney, Merrill Lynch, etc.

Still, I would only give him a B to a B+ as an investment manager.  I realize that it takes a certain amount of chutzpah (nerve) for a solo practitioner like me to judge someone whose firm manages approximately $4 billion and has thousands of clients – my goodness, Barron’s rated him the No. 1 independent financial advisor in 2009 – but I believe it is my responsibility to give you my opinion.  Read on, and see if you agree with my assessment.

Points of Agreement

First of all, let me state the areas of agreement.  I think his basic message is absolutely correct.  Most individual investors have so many misconceptions and make so many mistakes that their results are generally terrible.  Edelman provides a useful service in summarizing the theory, evidence, and his personal experience to educate the public on what really works.  He correctly points out that investing in safe instruments such as CDs is just about guaranteed to cause penury in retirement, because the “safe” investments don’t keep up with inflation, especially after taxes are considered.

He convincingly explains in great detail the necessity for wide diversification, proper asset allocation and rebalancing.  He also shows that listening to the media is bad for your investment results.  Good for him!

Like so many good investment managers, Edelman recommends having a long-term strategy and the importance of being invested at all times.  He was quite convincing in explaining how past performance is no guarantee of future results.  His down-to-earth “toaster” comparison was so good that I plan to use it myself when the occasion arrives.

He also explained in detail why retail mutual funds are just way too expensive.  These are not just opinions, but are based on facts.

He graphically illustrated the high cost of being “out of the market” for even a short time.  According to the data, provided by Standard & Poor’s, the average yearly return of the S&P 500 from 1994 to 2008 was 6.5% per year, if you were invested all 3,827 days.  If you missed the 10 best days, that’s right only 10 days, your return was actually 0%.  What a convincing comparison for a buy-and-hold all-the-time strategy.

So in general, I applaud Ric Edelman for being on the right track.

Where we disagree

My first criticism is that, although Edelman emphasized the long term cost that inflation inflicts on client portfolios, pointing out that over the long term inflation has been 3.2%, he says that it is “too early” to be concerned about inflation. He is “monitoring the situation” and will change his strategy when he thinks it is appropriate. In my opinion, this is a very strange approach for someone who believes that you cannot forecast the future.

Since markets react very quickly to new information, I worry that Edelman will not be able to change his strategy at just the right time. Why try to “time the market” by saying that inflation is not a concern now? To paraphrase an old Wall Street saying, “No one rings a bell to let you know when you should be worried about inflation.”

The question and answer portion of the seminar revealed a position that I take exception to.  Edelman suggests that paying off a mortgage quickly is a mistake, because clients can invest the money for a higher return.  While this is a controversial area, I believe that it is comparing apples to oranges, because mortgage debt is a certain obligation, while investment gains are variable.  As with many personal financial issues, the right answer is “it depends.”  There are too many variables in one individual’s life to hand out one-size-fits-all investment advice.  For some people, paying off a mortgage is the right thing to do, depending on their tax situation and their risk tolerance.  The peace of mind a debt-free retirement provides is valuable to some people who are no longer trying to maximize returns.

And, frankly, I am concerned that he is recommending something that will give him more assets to manage and therefore increase his fees, without mentioning the conflict of interest.

When I decided to look up Ric Edelman’s previous books, including The Truth About Money and The Lies About Money, I was surprised to see reviewers on Amazon.com chastising him for his previous rejection of index funds.  While Edelman now (appropriately) denounces actively managed retail mutual funds (because they are a rip off to investors with their high fees and hidden expenses), it’s unconscionable that it took him such a long time to realize that. 

It appears that Edelman had been attacking the notion of index funds for years.  Interestingly, he now follows a correct passive approach to investing, which is very similar to index investing.  He just isn’t willing to admit his conversion (or his past mistakes, for that matter).

In addition, I have read that Edelman doesn’t require that his advisors be Certified Financial Planners.  If true, this is a very serious shortcoming. Real financial planners address more than just investments, and while the CFP certification is not a panacea, it does indicate the seriousness to master your craft. More than passing a 10-hour test, the continuing education requirements are invaluable.

Fees and Value

Edelman Financial Services uses low-cost institutional mutual funds and ETFs, as do I.  The firm charges annual management fees of 2% on the first $150,000, 1.65% on the next $250,000, 1.25% on the next $350,000, 1% on the next $250,000, etc.  There is no additional cost for buying and selling mutual funds, which is a plus.  Another good thing is that they are willing to take on clients with modest amounts to invest, as low as $50,000.

However, while all-in costs are less than you might pay a typical stockbroker, I believe that for individuals with as little as $250,000 or $300,000 to invest, his fees are higher than those of a typical independent fee-only financial planner.

An investor with $500,000 will have to pay Edelman $8,375 per year as compared to a typical $5,000 fee to a smaller financial planning firm. An investor with $1,000,000 will pay Edelman $14,000 per year as compared to $10,000 for most boutique firms.  And many of the fee-only planning firms use the same low-cost institutional mutual funds and ETFs that Edelman does.

Conclusion

I have received mixed reviews from other financial planners regarding Edelman Financial Services.  Some call his portfolios cookie-cutter, which may or may not be a fair description.  Others have pointed out that there is very little attention paid to asset location, as compared to asset allocation. One financial planner told me that there was no effort to do tax loss harvesting, but another one said “it depends” on the client.  These are issues that many investors will not even be aware of, but the answers can influence after-tax returns.

Certainly Edelman’s services are better than working with a typical stockbroker, who might put you into a bunch of expensive retail mutual funds or sell you a variable annuity.

However, investors should understand that they are paying a premium for a celebrity’s name on the door.  And something a potential client should definitely ask is how much financial planning will be done, in addition to investment management.  The answer to that may also be “it depends.”

For a second opinion, and to help do a cost comparison, use “Find an Advisor” at the National Association of Personal Financial Advisors’ (NAPFA) web site and interview other financial advisors.

Making Better Financial Choices, Part 1

New Year’s Resolutions are often included as a part of every individual’s holiday tradition. My own resolution – not new, because it’s the same every single year – is to get more exercise. In general, though, resolutions don’t have a good record of success. Even as you’re reading this now, it’s likely that many of your own resolutions have already been abandoned.

But, if your resolution was and is to make better financial decisions in 2009, I applaud you. It’s an honorable and worthy goal, and one that can be achieved with relatively little pain. Helping individuals to make better financial decisions, so that they maximize their chance of achieving their goals: That’s my professional objective; it’s also another of my perennial resolutions, but one I faithfully keep.

Rather than writing my own killer “Top Ten Things to do to Get a Grip on your Finances,” I did a Google search on what has already been written. There’s an amazing amount of stuff out there on the net, some of which is quite basic – spend less, save more, have an emergency fund – but still apropos. There is one standout among the crowd, The Best Financial Advice Ever by Liz Pulliam Weston.

Assuming you already know the basics, here is an excellent article: 10 Resolutions to Fix Your Finances by Allan Townsend.

Although the last update was more than a year ago, this Money Central article is still a keeper. It definitely goes beyond the basics.

No. 1: Set up a system.
No. 2: Bank online.
No. 3: Take stock of what you own.
No. 4: Get out of debt.
No. 5: Create a budget.
No. 6: Review your 401(k) plan.
No. 7: Check your insurance coverage.
No. 8: Check your estate plan.
No. 9: Don’t give your money to Uncle Sam.
No. 10: Make new goals.

You’ll either find this list “old hat” or quite intimidating. There are links to further information on the various suggestions, and if you’re at all confused by what you’ve read, I urge you to read on.

Conclusion

For most people, developing a financial plan is well worth their time. Just as you plan a vacation, by carefully selecting a destination based on your needs, wants and desires, and determine the best way to get there given your individual situation, your financial decisions should involve the same type of strategic thinking.

After reading Townsend’s article, you may decide that you need help in analyzing your current situation, your required savings, and in developing a long term strategy. Thinking strategically and monitoring your results regularly will let you know if you are on track to reach your goals.  It will also indicate when you need to adjust your existing financial plan to match your new or changing financial situation.

It may not be easy to set up a financial plan by yourself, but you needn’t do it alone. A good financial planner will help you analyze where you are and what you need to do to achieve your goals. For most people, having an experienced financial advisor prepare a comprehensive financial plan is well worth the time and money.

Although you may be very successful in your own field of expertise, you may not have the time or inclination to keep up with changing tax laws and new investment products. There is no shame in delegating these tasks to someone who does them full time. You may also not have the discipline to manage your own investments, and there’s no shame in that, either.

The key is to start immediately. You need to harness your motivation now, create a plan and then begin to take the steps to implement it. A good planner will outline all of the steps required to reach your goals.

Financial Planning Pays Off

 ”If you don’t know where you are going, you might wind up someplace else.” – Yogi Berra.

An article at InvestmentNews.com discusses the results of a survey of more than 3,000 individuals, which was conducted this past summer. In my opinion, the results are striking, and represent a ringing endorsement of the need for comprehensive financial planning, which includes budgeting, insurance needs analysis, tax planning, investment analysis and recommendations, retirement planning and estate planning.

The survey divided the respondents into three broad categories: the self-directed investor working without a planner, those working with a professional adviser but without a comprehensive plan and those actively engaging in the financial planning process with a financial adviser.

Forty-six percent of self-directed investors said they were prepared for retirement, compared with 60% of the advice-supported group and 78% of those with a comprehensive plan.

Eighty-eight percent of individuals that were working with a financial adviser to develop a comprehensive financial plan felt they had a clear financial direction.

The comfort level of those with a financial plan was calculated at being 50% higher than those survey respondents who did not have financial support.

These results confirm why it is strongly recommended that you should have a comprehensive financial plan. For a detailed discussion, see Why You Need a Financial Planner.

photo credit: jsorbieus