Updated: Mar 30
In this post Bill Reviews a $5,000,000 portfolio and gives guidance for improving the tax risk, reducing the overall complexity, all while decreasing the total management fee.
I'm Bill Woodruff, Founder; Chief Investment Officer at WealthFactor. Today I'm going to go through and review a sample portfolio. It's a it's an offering we have here where we'll take a perspective investors portfolio and evaluate it and share our thoughts relative to its efficiency. The focus of WealthFactor is being risk smart. And to us that means focusing in on fee efficiency, tax efficiency, and then portfolio or structural efficiency.
So this particular sample that we're going to go through today was, was actually a real person that we did this analysis for, and we've blacked out the names on some of the materials to protect the innocent. So I'll just share real quickly what was received. We received set of statements from three different custodians, Wells Fargo, Fidelity, and Vanguard. So this one's a Vanguard one, and then Fidelity here.
A couple of different things that are, you know, stand out in some of these statements is the portfolio is comprised solely of mutual funds. And so this actually calls it out at Wells Fargo, Fidelity, and then the total value is approximately $5 million. Something that stands out real quickly to me is, you know, relative to that size, one having mutual funds at all and then two, and probably more notable is the use of "A" share classes. So it's worth noting that this particular investor does build their portfolio themselves. They're not using and paying an advisor to build this portfolio. Not to say that you might not see advisors or brokers more likely intentionally choose "A" shares for the compensation elements that are possible within them. Hopefully mostly just the 25 basis point 12b1 or trails, and not the loads.
So those are the three, in addition, which is pretty uncommon, and then also unnecessary, this particular I make my head smaller than the way, this particular investor shared with us a spreadsheet that they receive from a Morningstar tool that they use and so we took that same those same, that same information and created basically ways in which we could sort, categorize the data, the type of fund type of investment from an equity perspective, whether it's large, mid, growth, value, etc. Fixed Income we had credit quality, as well as interest rate sensitivity, so two different metrics there.
The biggest goal, though, is to identify the overall structure of the portfolio. With three different custodians, that's not simple, just from broker statements, we actually have to aggregate all these positions, and then do the formulas or math to to summarize what's there in aggregate. Custodial statements aren't generally providing the that sort of detail anyways. But if you're spreading out your assets across three custodians, you're really missing out, I think from doing that. And it's kind of worth sharing my view on on the idea of having multi custodial setup like this. The usefulness in my mind is really, really limited. I don't I know that there are people out there that kind of perceive there to be a diversification benefit of working with multiple organizations. And that might be true from an investment advice, and I would kind of hesitate there because I think about that world as being pretty commoditized in terms of holding assets, you know, outside of really small custodians which that world is really shrunk and there aren't many of those. There's not a whole lot of benefit to having your assets spread out across companies like Schwab, Fidelity, Vanguard. I mean, I wouldn't recommend using a bank or a broker to hold securities because of their business models having a lack of independence. The point there is more investing has plenty of complexities and to add a multi custodial structure to me, doesn't add enough benefit to warrant the extra administration, the tracking of multiple different custodians, and then just the difficulty of putting your head around and summarizing what you own.
What we do then is, after we go through the analysis, we evaluate based on our Philosophy, how we think about it, and it's all centered around efficiency. I think that in order to build an efficient portfolio, you have to do things in simple ways and weed out complexity at every possible, you know, point, again, under the priority that you have to be diversified. I'll just go through some of this, I may have touched on a little bit already. So there's three custodians, there's 26, positions, all mutual funds. One thing that's interesting about these positions is 15 of them are multi asset class. I consider myself to be a portfolio constructionist at heart, and the idea of using a multi asset class fund, and for those of you that aren't familiar, or maybe I'm even inventing terms a little bit, so let me define that. It's a bit of fund that has not just stocks in it, but perhaps stocks and bonds or, you know, potentially other types of assets. When I build portfolios, I steer away from those sorts of funds because I want to be intentional about what I own. And when you own a multi asset class fund, you're deferring that top level, what I own decision, to another manager.
So another data point here in this universe of funds is there are 12 funds that have an expense ratio of .6%. So, mutual funds are inefficient in multiple ways. One is the fee .6%. Perhaps I mentioned this already, but this particular investor does not have an advisor in place. And so this is a self built portfolio. And so at .6%, relative to paying an advisor to put them in a bunch of index funds, and then effectively having a total cost structure of 1.1%, this is actually probably better. Really, though, with a $5 million portfolio size, .6% is an all in cost for a portfolio that's simply just stocks, bonds and cash and most of the stocks are large and easy to invest in. Just like most portfolios, I see today there's a hyper diversity, there's thousands of total positions and so it's really become exposure to the overall market at this point.
It's important to look at the breakdown of taxable and non taxable assets, so there's just a slight larger amount in taxable, but there's a good amount both, which creates a nice opportunities for efficiencies. From an expense perspective, or just touching again on the mutual funds. One I think there's a expense inefficiency, but relative again to the advisor, that's not so bad. The bigger thing though, with mutual funds is the tax inefficiency. They're going to have an annual distribution that distribution has many potential influences that are outside of the investors control and whether it's a $1 million portfolio or $5 million portfolio, that ingredient is unnecessary. Whether it's just ETFs or with a portfolio like this, I'd actually recommend taking an index and building a portfolio based on an index using the individual securities and potentially attempting to add some value through some active Tax Management Systems. That's something that is very much viable here.
So back on track here, from a portfolio perspective, pretty standard in terms of 55% or so, equities. You know, I think largely because of the multi asset class and hyper diverse funds, there's a decent amount of non us Which you don't always see with, do it yourself investors. And then, breaking down in the analysis, growth, value, size, etc.
The one takeaway that I found throughout as I looked at the big picture was there was a pretty material tilt to growth. Personally, I don't like the idea of trying to bet on growth versus value. In general what we can do though is look at and say "Okay, well, growth is done really well for quite a while now, whereas value has outperformed on the very long term." At a minimum, I would look at this portfolio and say, it probably ought to be that that growth tilt is probably not timely. While it maybe had been very beneficial up until now, I'd probably look to unwind that right away.
Fixed income quality. Most of the fixed income mutual funds here are quasi total market sort of funds and so there's the full gambit of quality in terms of credit quality 33% below or junk. From a taxable investors perspective, I really don't like this exposure, and especially in the context of this portfolio. I'd much rather see more equity and not have these what are pretty tax inefficient, but speculative or equity risk like exposures in the portfolio. Also the to then looking at the interest rate sensitivity. There's some percentage of the portfolio in very long dated debt. You know, there's a diversification value there. So I don't necessarily feel as strongly about that from a shouldn't be in the portfolio, but I don't necessarily like that risk today, relative to the amount of yield or the compensation that's there, and I certainly don't like it and a mutual fund. There's no reason not to take control of those maturities through some sort of laddering of either individual bonds or even just ETFs that have finite maturity to them.
Just to kind of talk about the these elements a little bit more, a lot of this I talked about already. But you know, here are the kind of ways in which I might blow it out or highlight some of the key aspects to what I might do differently relative to this portfolio. The biggest takeaways for me, is starting at the top, what's the right asset allocation in this portfolio? What's the proper mix of stocks and bonds and then do we get to that front in an efficient way? And I look at that in from from fee perspective, from a portfolio structure perspective. So that part I think about as complexity, I think about it, "is this what's complex about here?" A mutual fund on the surface might sound simple, but if you have a multi asset class fund that really could be investing anywhere in the world and in multiple security types. There's really nothing simple about that versus a S&P 500 ETF which you know, explicitly what you own. Or,better yet taking those 500 stocks in the S&P 500 and owning them directly.
One element about this is there's not a layer, right? This is a do it yourself investor, they haven't hired an advisor, paying them a fee to then outsource the management to mutual funds. So there's a there's, as I think about this, from a portfolio and structure perspective, there's actually an efficiency there. From a tax perspective, very, very inefficient from a mutual funds standpoint. So looking to transition that portfolio there. And then again, kind of re highlighting the fee, part of that and the fee inefficiency associated with mutual funds and including the "A" shares. In many cases, I'll actually go through on a position specific basis and evaluate "does this, what are the merits of this particular position?" And in this particular case, the biggest consideration is the cost basis, is there a significant unrealized gain that, regardless of how much I don't like the structure or the expense ratio, does it make it hard to sell? In this particular case, there are a variety of Vanguard mutual funds that had very low expense ratios, and but an unrealized gain, that that exposure was efficient enough to make sense to recommend to keep it and avoid that game versus versus selling for a more efficient overall structure.
Typically, I'll share, what would I recommend in terms of what this would look like afterwards. Everything that I do is index based and so on here, in this particular case, it's got the existing Vanguard funds listed on here with their values. And then you can see since those are large, US the target for what I might build from a index based portfolio perspective in the large category is significantly less because those exposures already been achieved in a relatively efficient way.
Just to kind of summarize and conclude this portfolio is really ripe for a wealth factor efficiency improvement. So, taking and transitioning 60 basis point, .6% expense ratio mutual fund portfolio towards a largely individual security or fee efficient ETF portfolio implementation and then with the WealthFactor point .35% fee the prop the total expense of that portfolio is likely to go down, the opportunity to reduce and control tax will go up significantly. And it while we can't say it will certainly add value from a active tax management perspective, with the size of this portfolio, there's significant opportunity to actively add value through active Tax Management, removing of the "A" share class I think should that should happen really regardless,
As with a lot of things, there's there are variety of areas of complexity. The goal today was to give you a sense for how we think about portfolios. To the extent that you have a portfolio that's managed by advisor or manage yourself. If you just simply want to get another set of eyes on it, I'm happy to go through our process, do a portfolio review similar to this and share our thoughts and provide some feedback and with no obligation. Be happy to do it, appreciate you tuning in, and hope you have a great day.
About WealthFactor: A Lake Oswego based investment adviser and wealth manager serving local high net worth and ultra-high net worth investors. Founded on the idea that high fees force unnecessary risks when providing investment advice. By leveraging the investment methodologies of the largest passive and rules-based asset managers, WealthFactor seeks to pass on the benefits that efficiency provides through financial technology on to its clients. WealthFactor offers custom investment advice services conveniently through separately managed accounts in each investor’s name. For more information visit www.wealth-factor.com.
About Bill Woodruff: WealthFactor’s founder has been investing in publicly traded financial markets for over 20 years. His career includes founding an alternative investment manager, launching and managing a mutual fund and serving as a managing director of a publicly traded investment manager. With over a decade of experience serving high net worth investors Bill skillsets uniquely blend an understanding of investor needs with an extensive background in financial markets and investing.