Most financial planners offer to analyze a client’s 401(k) plan and develop an optimized portfolio utilizing the investment choices available. In most cases, the cost of this service is around $250. Some might wonder “wouldn’t I be better off simply investing that $250?” or “can my portfolio be improved enough to justify the $250 fee?”
First, do you know your 401(k)’s current allocation between stocks, bonds, and cash? Most people don’t. Study after study indicates having an appropriate asset allocation is the most important factor in determining investment success. If you have a portfolio that consists of a proportion of stocks to bonds that is too low or high relative to your risk tolerance, you will either not achieve your investment objectives or you will constantly lose sleep when your nest egg is declining faster than you can handle. Analyzing and identifying your risk tolerance should be included in your financial planner’s fee, as should determining the asset allocation of your current portfolio, as well as developing a stocks/bonds/cash mix that accommodates your needs.
Second, ensuring your 401(k) is adequately diversified should also be part of the process. The financial advisor should make sure you are investing in not only large cap stocks, but mid caps, small caps, and international stocks as well. Additionally, the planner should make sure you also have exposure to not just corporate bonds, but government and international bonds. Of course, determining the highest performing investment option in each asset category and identifying the percentage of your portfolio that should be placed into each portion of the diversification chart should also be part of the advisor’s duty.
Third, do you know the cost of each investment option within your 401(k)? Again, most people don’t. My associate recently reviewed a 401(k) that placed 31% of all assets in a money market account earning .08% and the total fees extracted were over 2.4%! The financial planner should identify the expense ratio of each mutual fund in your 401(k). After all, investing in a fund that is producing a high return doesn’t do any good if the return is being consumed by outrageous fees.
So back to the original question: is all this worth $250? Let’s take a hypothetical client, John, make some assumptions, and see if he is ultimately happy with his decision to tune-up his 401(k). John is 50 years old, has $100,000 invested in his 401(k), and intends to contribute $10,000 per year until retiring at age 65. He thinks he will live until age 95, and wants to know how much his 401(k) is going to allow him to spend annually until death. Lastly, we’ll assume inflation of 3%, and that John currently has a portfolio that will generate an 8% return annually. With these assumptions, John would be able to withdraw the inflation-adjusted equivalent of $26,654 per year from his 401(k) between ages 65 and 95.
Now, let’s assume John pays $250 to tune-up his 401(k); as a result, he is able to add 1% to his annualized return, either by enhancing his investments’ performance, or by reducing the cost of his portfolio. A 9% annual return would enable John to withdraw the inflation-adjusted equivalent of $33,087 per year from his nest egg between ages 65 and 95. That is $6,433 more EACH AND EVERY YEAR! I think it would be safe to assume John was happy with his decision to supercharge his 401k.
Another way to look at John’s situation is to ask what rate of return John achieved on his investment. A $250 investment yielding income of $6,433 for 30 years achieved a rate of return of 2,573%. Do you know any other investments that offer that type of return?