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Three Things: Fund Ratings, Long Term Care, Wrap Fees

February 04, 2020
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Here are a few recent thoughts on three particular subjects: 

  1. The "Best" Fund Companies (Morningstar) 
  2. Some Thoughts on Long Term Care Insurance
  3. Advisor Fee Structures and Comments About Wrap Fees


Adam Harding, CFP / Smartvestor Pro

If this is your first time receiving this email, here's some background: "Three Things" is a quick weekly email to recap some things that stood out to me in the previous week. I try to find inspiration in articles, videos, images, and anything else that I can tie into a financial planning or investment tip. Let me know if there's something you'd like to see covered, or if you happen to spot something interesting which you'd like to share. I hope you find this insightful!

Thing #1: The "Best" Fund Companies

Source: Morningstar Inc. 

Article Link

Article PDF


When investing, we have a lot of choices when we decide who to trust with our hard earned savings... 

Should we pick the company with their name on a skyscraper downtown? 

Should we choose the firm who bought a 30 second ad spot during the Super Bowl? 

How about we just screen for the best performing funds over the last 1, 3, 5, 10 years and go buy those? 


The answer? None of the above. 

When choosing a manager, PROCESS matters more than anything (yes, even more than recent performance). We can't understate the importance of the parent company's culture and how they view the world and approach financial decisions.

Some of you may have heard of Morningstar Inc., which is a firm that reviews investments and provides education and insight across global capital markets. Recently, Morningstar updated their list of The Best Mutual Fund Companies .

We don't put much stock into third party rating services when it comes to portfolio composition or performance evaluations, but when it comes to grading company culture we think it's worth trying to align ourselves with world class organizations. Culture is extraordinarily important.  

At the top of this list are two companies we strongly feel can add value for our client base (when used appropriately): Dimensional Fund Advisors (DFA) and Vanguard. Vanguard is pretty well-known (they invented the index fund), but DFA is lesser known. 

Here's an excerpt from the article above: 

"Dimensional Fund Advisors continues to be an outstanding steward of its shareholders' capital. … Co-CEOs David Butler and Gerard O'Reilly oversee a strong culture focused on market efficiency and transaction cost management.

Dimensional's investment strategies are rooted in research from the top minds in financial academia. These same researchers use a rigorous vetting process when developing new strategies or modifying existing ones. Proposals must be exploitable in a well-diversified, low-turnover, and cost-effective manner. Changes to existing strategies and the introduction of new funds are rare when they do occur"

I haven't found a company more committed to deploying academic rigor than DFA (perhaps that's because they're founded by Nobel Prize-winning economists). 

For those of you reading this who are not clients, please don't take this as a blind endorsement of the included fund companies. You still need to make sure a strategy is appropriate for you by either consulting with me directly or meeting with another financial professional. Even a great company may be managing a strategy that's too risky for you. 

For clients, these reports are by no means a standalone reason to adopt any strategy. However, it's always nice to see our opinions aligned with those of an independent research organization like Morningstar. 

For more on Dimensional Fund Advisors, here's a quick 2 page brochure DFA

Thing #2: Some Thoughts on Long Term Care Insurance

Supporting Article

There is no doubt about it, paying for Long Term Care can get EXPENSIVE. 

With life expectancy increasing and the world's population aging at a faster rate than ever before, an eventual stay in a long term care situation is becoming more and more likely. 

According to Genworth, here are some of the median monthly costs associated with care: 

  • In-home care: $4,290/mo
  • Assisted living facility: $4,051/mo
  • Semi-Private Room in Nursing Home: $7,513/mo
  • Private Room in Nursing Home: $8,517/mo

At those rates, we're looking at an increased annual expense of anywhere from $50,000-$100,000. As you can see, it could only take a few years to wipe out a retirement nest egg if you're under-prepared. 

[Enter Stage Left] Long Term Care Insurance

Because the cost of care can be huge, it's often widely recommended that individuals buy Long Term Care Insurance to cover these costs if they arise. 

The common idea with a LTC policy is that you buy it when you’re healthy and young (relatively, young), like at age 50 or 60, and pay a fixed premium for many years. If you keep up the payments then the insurer can’t deny you coverage if your health deteriorates. When you need and qualify for care, the policy will cover a certain amount of the cost, like $300/day for 3 years (or something like that).

But here's the problem: 

The insurer can typically raise the premiums in the future, while offering the same benefit. 

I'll say that once more for the people in the back... 

You can spend years and years paying your premiums only to have the insurance company decide you need to pay more to keep your existing benefit, or you can pay the same and receive a lower benefit. What? 

Honestly, I get why the insurer has to re-calibrate these policies; the actuaries who designed them wouldn't have anticipated the the cost of care to rise at 3x that of the overall rate of inflation. They also may not have expected people to live as long as they have been. 


For this reason, you need to be careful when evaluating whether long term care insurance makes sense for you. 


You might be saying, "But Adam, doesn't Dave Ramsey recommend that people buy long term care insurance?"

Yes he does, and he's absolutely right. 

However, Dave Ramsey also has noted that he himself does not have LTC coverage.

Why? Because he's built enough wealth to be self-insured.

This is my goal for every client I work with: 

Build enough wealth to self-insure against a long term care situation. 

If you're wealthy enough, then the potential impact of heightened care costs is limited to a lesser estate and legacy left to your heirs. 

For those with limited means, it can reasonably be assumed that Medicaid will cover their stay. 

The middle class is at the highest risk of LTC impacting their family significantly. 

To be clear, the situation we're looking to avoid is one where a married couple sees one spouse needing care, while the other is still healthy. The spouse needing care spends several years in a facility and the high costs drain the couple's assets. Then later on, the surviving spouse has limited resources remaining for their own lifestyle or care. 

Like every other financial planning application, this scenario requires making a ton of assumptions (guesses) about what the future cost of care will be, rates of inflation, premium increases, longevity, etc. etc. etc.... I always like the route that gives you the most flexibility and peace of mind. In some cases that may mean you should buy insurance; in other cases it may mean you should stockpile assets in your portfolio to pay for care. In ALL cases there is never a one-size-fits-all way to look at this; it's a highly personalized consultative process to determine what's best for you. 

With enough time and planning, we can build wealth to prepare for this situation. If we don't have time on our side, then we may need to look at insurance. 


Thing #3: Wrap Fees and Why We Don't Charge Them


There are several ways you can pay for investment advice: 

  • Commissions paid to a salesperson for helping you buy their product
  • A one-time financial planning fee
  • A fee based on a % of assets under management PLUS commissions from recommending products
  • A fee based on a % of assets under management (this is what we do). 
  • Performance-based fees and several other creative structures 

The reason we charge a fee based on a % of assets under management is twofold: 

(1) By not accepting commissions it helps us limit the potential for conflicts of interest. We don't want to be the doctor who prescribes his own proprietary medicine instead of the cure our patient needs. We call this Being A Fiduciary.  

(2) Our goal is to produce desirable long term outcomes and we feel the best way to do that is to have control over the investment strategy and collect a smaller ongoing fee as a sort of "retainer" to stay engaged.

Think of it this way: You can call up your favorite fitness guru and ask them to write you an independent workout plan for the next year. If you have the discipline to follow it by yourself through the ups and downs, great... But will your outcome be as good as if you met with that same guru 3 times per week for a year? Of course not. 

In short, we structure our service the way we do because ongoing PLANNING is more important than a PLAN. 

So now that I've defended our fee structure, let's talk about what an investor ACTUALLY pays when working with a firm like ours: 

  1. Our Fee
  2. Trading Costs
  3. The Expenses Within Individual Funds 

Only 1 & 2 are costs investors actually see.

The expenses within a mutual fund are embedded in the strategy and unnoticeable unless you do your digging. As an example, if a fund has a 0.2% expense ratio, you don't see 0.2% leave your account. It is simply reflected in the performance of the investment; you just see that you had gains or losses of ____% and the fund's fee is included in that figure. I'm a strong believer that the expenses within a mutual fund are often justified in exchange for the broad diversification and manager expertise provided by the fund. (limiting fund expenses is really important though, so I'll need to touch on that in a future blog). 

Some firms bill in a way that's very similar to us, only they charge a Wrap Fee to combine 1 & 2 above and they cover the trading costs on behalf of the client. Usually this Wrap Fee is larger than a firm would charge if they didn't cover the trading costs. (article: What is a Wrap Fee?)


While having one single all-in fee may sound attractive, when you're paying an advisor a Wrap Fee you have to watch out for something called "Reverse Churning," which is where you pay them a large fee to cover the trading costs for you, but since the advisor has to foot the bill for trading costs they refrain from trading your account much.

(This is the opposite of "Churning," which could become a problem when an advisor makes money each time you trade. They have the incentive to encourage more trades to "churn" the account to make more money. In our case, we have not incentive to trade your account more or less -- we just do what we think is best.)

While this Reverse Churning is something to watch out for when paying a Wrap Fee, there is another issue I'm seeing lately:

The fact that trading costs have gone WAY down in recent years.

You might remember when trading was a huge expense for investors, with stock trades running up to $100 or more. Even as recently as last year they were $5-$10 at most brokerages. 

Technology and competition has certainly driven down trading costs all the way to a point where stocks and ETFs now trade for free in many places (!) and mutual funds are as low as $9.99. 

If you're paying a larger fee which is designed to cover advice PLUS trading, but trading costs have gone down, then you might be overpaying if your advisor is charging you a wrap fee. 

This, among all the items listed above, is why we structure our fees the way we do. 


That’s all for now, have great week!


Adam Harding, CFP®