Wednesday, December 1, 2010

A Decision Costing People $894,000 Every 10 Years

I was chatting with a friend in regards to helping out his family with their finances. After speaking with family members their response was "we already use someone and it would be too much of a hassle to change." I responded with "that's an expensive decision."

To illustrate the loss of wealth or opportunity cost of that decision we should lay out a few facts.

First, looking at our own client's returns (before we retained them) over the past 10 years, ending 12/31/09 the average annualized return was 2.04%.

Secondly, according to the Dalbar (QAIB) the average of all equity investor's returns was -0.55%.

Additionally, a low-cost, globally diversified with Arianna Capital with a mix of 60% stocks and 40% equities achieved 6.29% annualized.

And lastly, inflation over the same period was 2.67%.

As we can see, the average equity investor was beaten by inflation. Additionally, before we retained our current client's their return was also trumped by inflation. Also, if a client would have chosen to retain Arianna Capital at the beginning of 2000, the client would have outperformed inflation and some.

So now let's do some math to illustrate how expensive this decision is under the aforementioned facts. The obvious solution would be to hold a global portfolio compensating investor's for taking appropriate market exposure, this can be found through Arianna Capital - $1,000,000 would have grown to $1,840,000. Let's compare this number to both, our client's past returns and the average equity investor's returns. Respectively, they are $1,224,000 and $946,000. Take whichever number you like to do your arithmetic. The net result is a difference of $616,000 to $894,000. A significant amount of money over just a 10 year period. Considering a 30-year old will be in the accumulation phase for 30-35 years, the difference can be staggering, even for a 50-year old.

We often find that when individuals respond with this decision, they usually have grown "attached" to their current advisor through golf outings and/or fancy dinners. Likewise, Do-It-Yourself investors become confident (epistemic arrogance) in their own abilities (active management). Both parties usually suffer from a lack of transparency - in which past returns, fees, and risk are unknowns. Similarly they don't know how to measure those three variables or end up inappropriately measuring.

The point is, the current relationship, whether it is with your advisor or your own money is usually extremely costly. In this case ranging from $616,000 to $894,000.

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