By Adam Nash, COO of Wealthfront
Investing well for the long term requires that you pay attention to three simple decisions and then apply a great deal of patience. Just about every academic who has studied investing will tell you that you are most likely to maximize your risk adjusted returns if you minimize your fees, diversify your portfolio and minimize taxes:
1. Low Fees. The biggest drag on portfolio performance continues to be high fees. You have to be on the look out for expensive commissions, fund fees and advisor fees. An advisory fee of 1-2% may not sound like a lot, but in a market yielding 5-6%, you might be giving up more than one third of your total gains to fees. Advances in technology now make it possible to find compelling investment management services with zero commissions and total fees well under 0.5%
2. Diversification & Rebalancing. Academic research has proven time and time again that a diversified portfolio offers superior risk adjusted returns to a portfolio that only consists of stocks or a few asset classes. It may be counter intuitive, but a diversified portfolio works best when automatically rebalanced which means selling your winners and buying more of your losers. The availability of low-cost, passive ETFs in a wide variety of asset classes and markets now makes it possible for a software-based service to optimally manage a diversified and rebalanced portfolio.
3. Tax Efficiency & Tax Loss Harvesting. Benjamin Franklin famously cited death & taxes as the only two things that are certain in this world. Too many investors, however, make investment decisions without taking taxes into account. Taxes can be minimized by investing in passive index funds and by taking into consideration the rate at which different asset classes are taxed when choosing an allocation for your taxable account and tax-deferred retirement accounts. Most importantly, the most sophisticated services will continuously harvest tax losses while maintaining the risk and return characteristics of your portfolio. Tax loss harvesting can save you at least 1% of your portfolio value each year on your tax bill.
Set Yourself Up for Success
It’s not enough to just get these characteristics right. As individuals, behavioral finance research demonstrates that we’re not always rational with money. Numerous studies have shown that individual investors don’t invest until the financial markets rise and then sell when they decline. According to DALBAR, this type of behavior leads the average investor to leave as much as 4% on the table each year.
Successful investors fight their basic human instincts to time the market (which again has proven not to be possible on a consistent basis) and instead choose to steadily and consistently deposit additional savings in their investment portfolio in good times and bad.
The Wealthfront Solution
Wealthfront can handle taxable accounts, IRAs & 401(k) rollovers. Wealthfront is the largest & fastest growing software-based financial advisor. Our mission is to provide access to the same high quality financial advice offered by major financial institutions and private wealth managers, like tax-loss harvesting, without the high account minimums or costs.
Our service manages a personalized online investment account for you that is fully diversified and periodically rebalanced – all with a low minimum balance of $5,000. Your first $10,000 is managed for free, and accounts with over $100,000 receive automated, continuous tax loss harvesting at no additional charge. Wealthfront’s service is commission-free, and charges only 0.25% for amounts over $10,000.
- You can learn more about the services offered and sign up at Wealthfront.com.