Note #2 to a good friend on investing

“Out of intense complexities, intense simplicities emerge”

― Winston Churchill

Dear GF,

I trust you’ve clicked on the links in my last post to learn more about risk and investment portfolios, advisor fees, and picking stocks.  There is a very substantial body of literature on these subjects – relevant articles, books, and papers range from those written for a layperson to those intended for an academic audience, so there is lots more to read.  If you’re so inclined….

Assuming you’re on board with my earlier post and what’s expressed in the linked articles, we can summarize the approach you should take as follows:  Diversify, keep expenses low, and create your portfolio with a sharp eye for your tolerance for risk.

OK.  To diversify, one can purchase mutual funds and Exchange Traded Funds (ETFs).  There are thousands of these to choose from, funds for virtually any investment category.  My advice is to Go Big – that will be the simplest and easiest way to achieve diversification, subject to the vehicle having low costs.  Fortunately,  a well known vendor, Vanguard, has several mutual funds and related ETFs that are both large and inexpensive for their categories, such as VT, VTI, VWO, and others.

Second, to keep expenses low, select low cost vehicles (such as Vanguard ETFs), and go with inexpensive advisory services.  The lowest cost approach to advisory services is of course to do it yourself with no fee to a third party.  If you are not comfortable with that, there is a large menu of service providers:  personalized service at 1-2%/yr. on assets managed as well as Internet based services from around 1%/yr. down to a fixed fee of a few dollars/mo. for small accounts with very limited advisory services.

Your ability to tolerate risk goes hand in hand with the returns you’re likely to achieve over the long run.  More risk = higher expected return.  In the context of an investment portfolio, equities are riskier than fixed income instruments or cash, and this mix deserves your careful attention.

You asked that I recommend what you should do and that I suggest what service providers to use.  (I advise against and assume you do not wish to pay the 1-2%/year that a high-service advisor will charge, mostly for what amounts to handholding.)  For a lower fee structure and lower service level there are a number of cloud-based providers.  Most are relatively new, pre-profit, often backed by venture capitalists, and have unproven business models.  The exception is Financial Engines, which was co-founded in 1996 by Professor William F. Sharpe, a recipient of the 1990 Nobel Prize in Economic Sciences for his pioneering work on the theory of financial economics, including how prices of financial assets are determined and the link between risk and return.

I was fortunate to be a student of Professor Sharpe at Stanford, and have always respected his exceptional mind and fact-based, follow the evidence approach.  I’m confident his thinking and personality have permeated Financial Engines and that they provide a quality service.  And, fortunately, their service is very reasonably priced at $300/year.  (Better yet, some fund companies such as Vanguard, waive the Financial Engines fee in certain circumstances.)

So, there you have it: engage Financial Engines.  Go through their process to gain insights on your ability to tolerate risk and what that implies for your portfolio.  I understand that the process will eventually yield recommendations as to your portfolio mix and specific instruments.

Thank you for asking for my advice and offering the chance to express myself!

Your friend, Krist

P.S. By the way, an excellent site for additional information on low cost investing is http://Bogleheads.org.

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About Krist

Companion of Wally who is featured at MrWally.com. More at https://www.linkedin.com/in/kristjake/
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