July 5, 2007 by Matt McCracken
In short, the answer is very little. Index investing is basically a commodity and the profit margin on a commodity will eventually be reduced to zero. In order to manage a portfolio of index funds, advisors are required to carry out the following two points of execution:
- Step 1: Pick an appropriate model portfolio out of a book based on your age and risk tolerance, assign your account to that model and click the mouse on the button that says “Allocate Portfolio”. (Time spent – 15 minutes.)
- Step 2: Repeat Step 1 every 12 months. (Time spent – 1 minute if you can remember the login information for your broker. Otherwise, 5 minutes.) (I admit than many Index fund advisors provide annual financial plans in addition to the aforementioned, incredibly time-consuming tasks. Time spent – 1.5 hours)
- Despite its simplicity, it has come to my attention that there are advisors charging over 100+bps or 1% for an indexed strategy. The hypocrisy of it all is that American financial advisors who promote index investing do so because of the low cost structure of indexing, yet they charge around 1% for practically no work. Assuming that your account is worth $500,000 and you’re paying 1% for management, that’s a $5,000 annual fee for approximately 2 hours worth of work. That’s $2,500/hour! What an incredible gig! Hell, I’d get it into if I wasn’t so painfully aware of how poorly domestic equities and bonds will perform over the next 5 years. Conclusion 1: You could do a lot worse than an index investing approach by buying expensive, actively managed funds that consistently underperform the market. Conclusion 2: Unfortunately, you’ll still lose money in an index fund approach over the next several years as equities and bonds seek to reach more normal valuations. Conclusion 3: Index investing is a losing strategy in an inflationary environment. Inflation was uncharacteristically low in the 80’s and 90’s so investors are discounting it. Conclusion 4: DON’T OVERPAY FOR INDEXING! Do it yourself by following Scott Burn’s strategy, The Couch Potato Portfolio, or find an advisor that will only charge you 10 – 20 bps for 2 – 3 hours of work each year. Better yet, have them charge you an hourly rate instead.