Advisors Call Out Needless Complexity in New Clients' Portfolios

What You Need to Know

Rick Ferri and John Luskin say new clients often come to them with advisor-built portfolios laden with redundant holdings and high fees.
They argue that some advisors are creating complexity in order to justify their value.
Portfolio simplification must be done carefully to avoid tax consequences.

Jon Luskin, an advice-only, fee-only certified financial planner serving do-it-yourself investors, occasionally tweets about what he considers to be needlessly complex, inefficient and costly portfolios that new clients sometimes bring from other advisors.

“Here’s yet another advisor-managed portfolio, with countless high-fee, tax-inefficient mutual funds in a taxable account,” he tweeted in November with a photo of the holdings. “The good news is that the portfolio manager will get fired.”

Luskin, who doesn’t manage client funds, has called out other portfolios as well for their “overlapping funds” with similar exposure and high fees, and for holding tax-inefficient funds in taxable accounts and low-returning bonds in tax-free Roth accounts.

“You don’t need complexity to be a successful investor. In fact it’s quite the opposite,” he told ThinkAdvisor recently. Luskin, who hosts the “Bogleheads Live” Twitter program for the John C. Bogle Center for Financial Literacy, is hardly alone among advisors who find some new-client portfolios too complicated and costly.

Too Many Securities?

Rick Ferri, an hourly-fee advisor and host of the “Bogleheads on Investing” podcast, said most clients who come to him from other advisors bring portfolios with 15 to 50 securities, including redundant funds. Like Luskin, he advocates the late Vanguard founder John Bogle’s low-cost, index investing philosophy.

Most investors can do well with only two to four index funds, Ferri suggested, saying there are multibillion-dollar pension funds that invest this way. Simple index funds and portfolios tend to outperform, he said.

“My job is to simplify the client’s portfolio so that they can self-manage it, and then it prepares the portfolio either for their spouses who continue to manage it or children or someone else,” Ferri told ThinkAdvisor. Simplifying a portfolio usually means cutting down considerably on the number of securities that the client brings, he added.

Even advisors using indexed investments sometimes divide funds by market capitalization, styles, regions or other elements, Ferri said. Rather than being invested in a total U.S. stock market index fund, the portfolio will be “sliced and diced into a Humpty Dumpty portfolio,” he said. Advisors may similarly divide global stocks by regions or market cap when one total international index fund would be cheaper and less complex, he said.

Jim Williams, chief investment officer at Creative Planning, a comprehensive financial advisory and investment management firm, also sees portfolios with securities he considers to be risky and too complicated, as well as those with overlapping holdings.

“You most often see complex portfolios that have friction either through high taxes or expenses, more often than not coming from the wirehouses,” he told ThinkAdvisor.

Williams cited two examples of complex investments, sold on commission, that he sees in many new-client portfolios.

Structured notes seem to offer a lucrative opportunity but bring significant drawbacks, including unfavorable tax treatment and a lack of dividends that could translate into much lower returns than a fund representing the same underlying index, he said.

Structured note gains are taxed as normal income — the highest rate — rather than as long-term capital gains, and offer no dividends, which means investors stand to miss out on substantial yields, Williams said. “My view is this is a terrible investment,” he said.

Fixed income, closed-end levered funds also complicate portfolios, bringing embedded risks and high fees that may make them less safe than clients believe them to be, he said.

Simplicity vs. Complexity

“Simplicity is better than complexity unless complexity offers you an advantage,” Williams said. Clients often come to Creative Planning seeking comprehensive wealth advice and to consolidate portfolios that have accumulated various investments over the years, he said.

Adding Value

While Williams of Creative Planning agreed that some advisors may needlessly complicate portfolios, he suggested there’s more to the situation than the type of advisor or fees.

“I believe that some advisors do make portfolios more complex to try to show they are adding value. I also believe that this can potentially occur in a scenario where an advisor is trying to justify a flat rate or a fee on the assets they (are) managing. In both cases advisors may look to justify their fees in ways that don’t make sense,” he said.

“When we think about the value proposition we bring to the table, it is not based on any single piece of advice but instead it is an amalgamation of all the things we advise upon. The client’s team consists of a CFP, JD and CPA. We practice tax and law. We will provide advice on anything that impacts their life from a financial standpoint” and bring in specialists as needed, Williams said.

This approach provides advisors a number of tangible ways to add value and alleviates the need to justify the fee based on investment complexity, Williams added. The ability to offer tangible, mutli-faceted advice “is likely a better proxy than whether the fee is a flat rate or based on managed assets when assessing this potential conflict,” he said.

Peter Mallouk, Creative Planning’s president and CEO, noted via email that a low-cost, index-based portfolio “is likely going to outperform most active or complex strategies.” While evidence suggests some other investments can outperform in the long run, “most include illiquidity risk, active tax management or other considerations.”