If I were to write a job description for a portfolio manager, I would include the following list of responsibilities:
- Act as fiduciary (act in my best interest and not for their personal gain).
- Allocate portfolio funds in broadly diversified index funds rather than individual stocks.
- Avoid high risk or leveraged securities including options, commodities, futures, etc.
- Utilize modern portfolio theory by diversifying funds across inversely correlated asset classes to maximize returns for the amount of risk that I am willing to take.
- Re-balance my portfolio periodically to ensure my portfolio’s asset class allocation doesn’t drift off target.
- Allocate new contributions towards depreciated funds to avoid unnecessary re-balances.
- Select highly capitalized index funds with high liquidity and low expense ratios.
- Divide portfolio funds across stocks and bonds while also increasing my bond exposure as I approach retirement (bond allocation roughly equal to 120 minus my age).
- Ensure asset class index fund account placement is tax-efficient (bonds and REITs located in tax-advantaged accounts, high growth stocks located in taxable accounts).
- Perform tax loss harvesting by exchanging deprecated funds for similar asset class replacements which results in deductible savings on tax returns and increased returns in the long-term.
Who Would You Hire?
The first question you should ask is whether you have the expertise, time, and dedication required to hire yourself. Here’s several of the most common ways that this plays out:
- You attempt to implement the full solution yourself.
- You compromise on several responsibilities and implement a simplified version yourself.
- You pay a high cost human financial advisor to do this for you.
- You pay a low-cost robo-advisor to do this for you with software automation.
My Failed Attempt
About eight years ago I decided to become my own portfolio manager. I created an elaborate Excel spreadsheet, opened a Vanguard account, and executed trades according to my plan. For the first month everything was perfectly allocated according to my plan. Despite knowing exactly what to do, I failed to execute each of the responsibilities on a day-to-day basis. Some of the index funds appreciated while others depreciated and my target allocation balance had drifted off target. Furthermore, I had new savings that needed to be allocated towards the different funds. Since I was using ultra-low cost ETFs (exchange traded funds) I had to set limit purchase orders for each of the trades. I spent too much time looking at stock charts in an effort to set appropriate limit prices for the orders. Work, family, and life consumed my energy. In the meantime, my well-designed portfolio had drifted off course. I quickly realized that managing a portfolio required dedicated attention and time that I did not have.
Simplified Compromised Portfolio
For those who subscribe to the KISS (keep it simple stupid) principle, the easiest way to implement the above is to invest all of your money in a Vanguard target date fund. A target date fund is composed of different index funds across different asset classes. The stock/bond split is automatically adjusted over time as you approach your target retirement date. These pre-packaged funds are an excellent option for keeping things simple. However, choosing this option will force you to miss out on tax loss harvesting and tax efficient fund placement. These funds also typically do not have good representation across all important asset classes including REITs, small cap stocks, and emerging markets.
Automated Approach
As a software engineer, I love to leverage the power of code to automate tedious tasks. Portfolio management is extremely well-suited for software automation. Having learned my lesson to avoid manually managing my portfolio, I decided that I was going to write a fully automated service to implement the plan. As I worked on the idea, I realized this solution could benefit others. As I evaluated the startup competitive landscape, I discovered a local company called FutureAdvisor which had recently graduated from a startup incubator called Y Combinator. Their product was exactly what I had envisioned and so I contacted the founders to explore a partnership or just join them outright. They were an amazing team and I was excited at the thought of contributing to their mission. However, FutureAdvisor had plans to relocate to Silicon Valley and I couldn’t relocate my family from the Seattle area at the time. We parted ways but I became an early adopter and supporter of their service.
Robo-Advisor Options
Over the past several years, the robo-advisor landscape has become crowded with many different companies. I’ve spent a lot of time evaluating different services and I personally recommend family and friends to use one of the following two similar services:
- Betterment – lower cost for larger accounts, excellent usability and customer features, portfolio includes diversification across small cap and mid cap stocks.
- Wealthfront – portfolio includes REITs, provides advanced tax loss harvesting capabilities to capture additional gain opportunities.
For an in-depth comparison to help you choose between the two services, read Betterment vs. Wealthfront – Which is the Better Robo Advisor?
I personally use FutureAdvisor because I’m grandfathered into their legacy fixed cost pricing structure. The service they provide is unparalleled at this rate. Unfortunately, their pricing is much higher now which is why I recommend either Betterment or Wealthfront.