Most of our compensation is fee based which includes asset management fees and trails. A smaller portion of it, usually from insurance based financial solutions, is a commission from an insurance company.

Let’s have a conversation about fees. Most in our industry believe and teach that it is important to invest with a money manager that has the lowest possible fees. Although we are not opposed to low fees, we do not entirely espouse that philosophy. We believe this philosophy is based on theories that are incomplete and potentially harmful to investors’ portfolios especially during severe bear (declining) markets.

Market history has taught us that there are four major things that affect the performance of a portfolio: market risk, taxes, inflation, and fees. Theoretical models add asset allocation, security selection, and timing. The least of these, in terms of magnitude of impact on the performance of the portfolio are fees. Advocating for low fees sounds very ‘consumer friendly’.  More important than low fees, we feel it is in our clients’ best interest to protect them from market risk.

Do low fees protect a portfolio against market risk? No, low fees do not protect a portfolio against market risk. This may be contrary to what you have been told.

Index funds or exchange traded funds (ETFs) have the lowest fees. However, index funds and most ETFs have no active management. Our industry has depended on the theory of negative asset class correlation (the hope that when one asset goes “zig” another asset goes “zag”) to reduce market risk and hence the volatility of a portfolio. We saw that from the peak of October 9, 2007 through the trough of March 9, 2009 that theory didn’t work. Many portfolios that depended on the theory of negative asset class correlation and low fees went down 40% to 50% or more. When a big decline occurs in the market low fees do not help protect the value of the client’s portfolio.

It is important to understand that the opposite is also not true. That is, higher fees do not assure good performance during bear markets. We know that active managers charge a fee. Our specialty is finding the “sweet spot”.  That is, to find experienced money managers who actively manage money with a “risk management” philosophy. Thereby protecting your money against severe bear (declining) markets while attempting to capture a majority of the rising market.

Why is protecting the value of your portfolio against major declines so important? Example: Investor A has $1,000,000 and a low fee manager that depends on diversification through negative asset class correlation to deal with market risk. Investor B also has $1,000,000 with a higher fee defensive money manager that also diversifies but in addition adds a tactical component to reduce market risk in the event diversification fails.

A 50% market decline occurs. Investor A’s portfolio is now worth $500,000. With defensive money management Investor B’s portfolio is now worth $900,000. It will take Investor A 100% in growth to break even to the original $1,000,000 value. On the other hand, it will only take Investor B’s portfolio 11.1% growth to break even. It will take Investor A nearly 90% more return to the upside to break even, versus Investor B’s portfolio.

We are strong believers in active defensive money management and not just diversification with periodic ‘re-balancing’. Defensive money managers typically charge between 1.5% to 2.75% per year to manage an account.  The average fee is usually between 2.25% to 2.50% for smaller accounts and less for larger accounts.

Our compensation is included in this fee; hence an investor gets both the defensive third party money manager and our expertise for only one fee and not two fees. Also, it is important to know that these managers are not incentivized to make trades in the account for a commission, because they receive no commission. Their compensation is not based on activity but rather on value. Like us, they are incentivized to increase the value of the portfolio because as the portfolio value increases so does their compensation. We have an incentive to monitor the success of the defensive money managers that we use.

With the advances in technology, today an investor can have a diversified portfolio of different styles of money managers using different asset classes.

Most defensive money managers typically have a minimum size account of between $50,000 and $100,000, a few a little lower and some a little higher. 

We would be happy to discuss strategies to manage risk in your portfolio. Click here to get started.