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BY WARREN BOROSON

NEWJERSEYNEWSROOM.COM

BOROSON ON MONEY

A woman I know, in her 70s, has a nest egg of $500,000. Her financial adviser just retired and she's looking for a new one. I gave her some names – the usual suspects.

From her $500,000 she gets around 3 percent from a mixture of stocks and bonds, mostly bonds — or $15,000 a year. But that income, plus Social Security payments, she tells me, just isn't enough.

Unfortunately, every financial adviser I had recommended wanted 1 percent of her assets every year to manage her portfolio. That would bring her income down to $10,000 a year. (And to make up the difference, an adviser might put the woman into a slew of high-paying but riskier investments, like junk bonds.)

Is 1 percent – the standard charge for managing an average-sized portfolio – too much?

♦♦♦

Perhaps not, say several local financial advisers. (Their comments are below.)

But Richard A. Ferri, author of "The Power of Passive Investing" (2011), strongly believes that 1 percent is too much – even though he himself manages nearly $1 billion in separate accounts for wealthy investors through his company, Portfolio Solutions. He charges a flat $2,500 – which, on a portfolio of $500,000, amounts to 0.5 percent. That's half what most other financial advisers charge.

Ferri makes a strong case for a lower fee.

Most investors, he argues, would be better off with a "passive" portfolio rather than an "active" portfolio. With low-cost index funds (which merely follow the investment markets) rather than actively managed portfolio (which try to do better than the investment markets). There's a load of evidence to prove this.

And how much should someone charge for putting all (or most) of your money into (for example) a target retirement fund that uses index funds? The adviser doesn't even have to make your portfolio more conservative as you grow older; a target-retirement fund does that automatically.

In his book, Ferri writes that "Advisers who use active management promote the hope of market-beating performance to sell their services to prospective clients. The glitter of potentially higher returns works on prospective clients because people like to believe they're going to win. Chances are they won't win, but until the clients figure this out, the adviser collects [a] hefty fee."

At this point, let me interject my own views: Some advisers deserve 1 percent. Some are very, very good at what they do. It IS possible to beat the market – as people like Warren Buffett have shown. And even if an adviser's portfolio doesn't beat the market, he or she might provide you with a portfolio that does unusually well, considering how unrisky it is.

But such advisers are not common. Most advisers deserve less than 1 percent. Unless they do much more than just managing your money, like giving you tax advice, estate-planning advice, insurance advice, and so forth. Still, paying Fred or Fannie the financial adviser 1 percent and expecting him or her to beat the market is ridiculous.

When I've examined portfolios recommended for clients, what I usually see is: a surprisingly complicated portfolio. As if the adviser is trying to say, "This stuff is much too complex for little old you."

Here's an interview with Ferri:

Newjerseynewsroom: If an adviser puts someone into passive investments, what might he or she charge? 0.7 percent? Or more? Or less?

Ferri: The investments that advisers put their clients' money into [may have] no bearing on the adviser's fee. Some advisers use active managers and charge a low fee, and many use index funds/ETFs and charge 1 percent or more.

One such adviser is also a nationally syndicated radio host. He preaches 'low cost' using index funds and ETFs on his show while charging clients as much as 2.0 percent in management fees per year to manage their money. There's no excuse for this.

NJNR: What's the minimum you would charge?

Ferri: Our minimum HOUSEHOLD fee is $2,500 per year. Assuming that a household has only one $500,000 account, a fixed annual fee of $2,500 would be charged. [That's 0.5 percent.] The fee would stay fixed at $2,500 per year until the assets exceed $1 million.

NJNR: What if the portfolio is extremely simple? For example, a lifecycle fund or a target retirement fund?

Ferri: No adviser is needed if a person is going to use a balanced fund of index funds. A balanced index fund is a perfectly fine way to invest. We recommend it all the time, especially for people who really don't have enough money to diversify on their own or pay an adviser to do it. The only disadvantage is that you can't tailor the portfolio to your needs. It's a pre-packaged mix.

NJNR: What if an passive portfolio is actively managed? In and out of different ETFs, for example, depending supposedly on market conditions?