Value Justification
How Scott Dauenhauer & Meridian Wealth Management Add Value
A financial planner is more than just a money manager. Yes, many of us make our living by charging a fee based on your assets, but that is purely a function of how the marketplace has evolved, not a function of where our value lays. True value can be added in portfolio management as I will explain later, but the long term value is in having an advocate whose sole job is to make sure you are on track to meet your goals. What is more important, beating the index by .50% this year or knowing that you have done everything you can to ensure that you are on track to pay for retirement or for a child’s college education? Don’t get me wrong, returns matter, but they need to be put in the proper context. What follows are many of the reasons why I believe it is worth your money to me as your financial planner and investment manager. You can click on the following links (from top to bottom and left to right) or simply start scrolling.
Value Justification for Ongoing Relationship - Investment
My investment philosophy is fairly simple. We build a diversified portfolio and hold on to it for the long run in accordance with your goals and your need/ability to take risk. With such a seemingly simple way of managing money I occasionally get asked the question “why should we pay you an annual fee to “manage” the portfolio for us, what are you doing to “add value”?” This is a good question.
Most planners justify the fee they charge you by telling you how much work they do to find the “next best” manager. They tell you that they scour the universe of 12,000 funds to find the best one’s this year and because they are able to do this better they will add value in terms of return, thereby justifying their fee. The problem with that justification is two-fold, first it ignores the fundamental relationship between a financial planner and his/her client, and second, the planner is rarely successful in identifying superior managers ahead of time (though they try to fool you by using last years superior manager).
Choosing Superior Money Managers
Most planners sell their services to you on the basis that they have the ability to foresee what mutual fund managers will outperform all the other managers and indexes next year. They justify their fees on the basis that they can add more return than they subtract in fees; the problem is that over the long run this is a failed policy. Nobody knows what will happen next hour, let alone next year. The probabilities of your planner being able to choose a top tier manager going forward are not good, over the long run less than 20%. Over the long run only about 20% of money managers outperform their benchmarks. As if that wasn’t a big enough indictment of “active” money management it has also proven nearly impossible to identify those managers who will outperform in advance of their outperformance. Not only that; but the out-performance of the chosen few is rarely something to write home about. The 80% who under-perform usually do so by a margin of over 2% annually. If you assume that the 20% who out-perform do so by a margin of 3% (meaning they beat the index by 3%, which is very unlikely) you’re expected return, using actively managed mutual funds would be 1% less than the return of the benchmark. In other words, the probability of outperforming a benchmark by using active managers is very, very low.
Money Managers Under/Over Performance Probability Net Return
Outperforming +3% over index 20% .6% over
Underperforming -2% under index 80% -1.6% under
Total Return added/subtracted -1% (.6% + -1.6%)
The value justification of most planners is completely discredited, but the question still remains, why should you pay me to be your financial planner & money manager, especially given my investment style? You certainly shouldn’t do it out of the goodness of your own heart, you should be getting value in return for the fees you pay and what follows are the reasons that I believe my fees are justified in light of the services and value that I offer both tangibly and intangibly.
Compensation & Conflicts of Interest
Jack Waymire, author of Who’s Watching Your Money and founder of www.paladininvestors.com says “If you want to minimize the major source of conflict; then you have to be the advisors sole source of compensation, and there is only one way to do that. You must pay fees, not commissions, for the services that you use to achieve your financial goals.”
Scott Dauenhauer & Meridian Wealth Management does not sell any products and we do not accept any commissions or referral fees for the services provided. This is important because you know that you are getting objective, unbiased financial advice from a source that has your best interest at heart.
Scott Dauenhauer is a Certified Financial Planning Practitioner ® and a NAPFA Registered Financial Advisor. In addition, Scott is nearing completion of his Masters in Financial Planning. According to the U.S. Dept of Education only about 8.7% of adults over age 25 have earned a masters degree or higher, while there are not any official numbers as to what percentage of the advisor community has earned their masters in financial planning you can be sure the number is low, I would gauge it at under 1/10 of 1%. Scott is an accomplished financial author and has been quoted in major newspapers and magazines including the Wall Street Journal & Smart Money magazine. It is vitally important that you hire someone who is committed to improving themselves and having the knowledge to guide you through the important decisions you make with your money.
At last check there were over 650,000 “advisors” roaming the United States, the majority however are product pushers. They are compensated to sell, sell, and sell. Much of the value that you receive through Meridian is that you know the advice you receive is not tainted by unseen conflicts of interest and motivations. There are no hidden motivations behind the recommendations being made, thus you can have peace of mind and feel comfortable that the advice you are receiving is motivated by your goals, not someone else’s.
Another area that sets Meridian Wealth Management apart from others in the financial services industry is that we serve you as a Fiduciary. A Fiduciary is someone who is required to put their client’s best interest above their own. There are very few Fiduciaries in the market place because most brokerage firms are scared of the liability they face when they are forced to put their client’s interest ahead of their own – most simply can’t do it. At Meridian we don’t feel “forced” to put our clients interest ahead of our own, it comes naturally because we respect our clients. Why would you ever do business with an entity that wasn’t legally required to put your interests first?
At Meridian our fees are lower than the competition; however we don’t believe you choose an advisor purely based on low fees. Our low fees stem from a fundamental value and belief that over time fees make a big difference in a client’s portfolio. The more we can do to reduce fees for our clients while still providing a top notch service the more money our clients will make. We believe our fees are reasonable in light of the services and the value that we offer and we can usually lower your fees by 30 – 50%. Imagine, actually receiving service from your financial planner and paying lower fees! By the way, Vanguard offers an over the phone service that tries to emulate what Meridian does, of course they charge more for doing it and limit their recommendations to investments and only Vanguard funds. Vanguard charges .75% on the first $1 million, .35% on the second $1 million, and .20% thereafter with a $4,500 minimum annual fee. Vanguard charges 50% more than Meridian on the first $1 million dollars and yet cannot provide the same level service, expertise, commitment, or objectivity. I am able to offer lower fees for two reasons:
1.) I have committed myself to making less money on an annual basis than the average planner so that my clients can see more benefits. This doesn’t mean I am limiting my income to that of a social worker, simply ensuring that I am not making excessive income at the expense of my clients.
2.) I utilize the best available technologies and work to keep overhead as low as possible. You will not find me in a fancy office in Newport Beach nor will you be offered worthless concierge services. If I can run my business in an efficient and lean manner then my clients and I will benefit in the long run.
I recently worked with a couple who had their money being managed by a popular “no-load” fund company. They received no investment advice and no financial planning advice; they had no one to call with questions. After looking at their portfolio and life goals I was able to offer them my services at a lower cost then they were currently paying at the no-load company, the difference being that with me they actually receive ongoing advice, service, and planning. My fees are so competitive that many of my clients save over 80% from their previous planner. There is a reason people who work at large brokerage firms are called “brokers,” in the end they make you broke – er than when you started.
You may think that given our investment strategy that what we do with your portfolio is easy. That isn’t necessarily the case, there is a lot of work that goes into building, maintaining, and monitoring your money that you don’t see.
Disciplined & Cohesive Strategy
Most families do not have a portfolio; they have a bunch of stocks, bonds, mutual funds, and cash that have been picked up from numerous sources. Whether it was a stock tip from a friend, a mutual fund recommendation from a broker, or a recommendation by Money magazine most portfolios have no singular strategy. There is no discipline in the management of the portfolio and most people forgot why they bought what they bought in the first place.
At Meridian we focus on ensuring your portfolio has a clear purpose. All portfolios are based on your need for risk and the goals you want to achieve. We employ a disciplined strategy that has been proven by time and we build cohesiveness into your portfolio. Every selection in your portfolio is chosen for a reason. We build your portfolio across all of your accounts – meaning that we will work to ensure your allocation includes every account you own, even accounts that we don’t have as much control over such as 401(k), 403(b), & 457(b) plans. Our goal is to make sure that we have the best investments placed in the correct accounts and that everything is working together for the greater good of the portfolio.
Most people are concerned about losing money, this is understandable. Studies have shown that a diversified portfolio should fluctuate less than a straight market based portfolio. A good example was the last bear market we had. The last bear market started in January 2000, had you invested $10,000 in the Standard & Poors 500 and an additional $10,000 in a Diversified portfolio of equities, how would you have fared? The following Table shows the comparison at different times during the bear market:
Investment of $10,000
Time Period S & P 500 Index Diversified Portfolio
January 1st, 2000 $10,000 $10,000
December 1st, 2000 $ 9,100 $10,000
March 1st, 2001 $ 8,000 $ 9,600
September 1st, 2001 $ 7,200 $ 9,100
September 1st, 2002 $ 5,700 $ 8,600
September 1st, 2003 $ 7,100 $11,600
January 1st, 2004 $ 8,100 $13,800
April 1st, 2004 $ 8,000 $13,700
Source: DFA Returns Program
As you can see, diversification can make a big difference. Now, we can’t and won’t guarantee that a diversified portfolio will always hold up this well. In fact, the way a diversified portfolio performed during this recent bear market was even shocking to me. The point is that diversification not only works, it leads to better returns with lower fluctuation over the long term. This is why we focus so heavily on building a diversified portfolio of index funds, not just purchasing the S & P 500.
Your own behavior poses the biggest risk to your portfolio’s performance, according to a study conducted by Dalbar, Inc., a financial market research firm. The study, which measured the money flow in mutual funds from 1994 to 2002, found that the average investor earns less than the rate of inflation on their investments (see Table 1). Chasing yesterday’s hot performers, market timing and reduced holding times were the main reasons for poor returns, according to Dalbar.
The study’s results suggest that a person holding a simple index fund and doing nothing during the same time period would have easily beaten the vast majority of investors. Yet, most people still think of investing in passively managed funds as a naďve strategy and, when trying to improve upon it, reduce their returns in the process.
At Meridian we help you stay focused on the long term. We do not flip in and out of investments based on short term market fluctuations or based on what sectors may be hot or cold next month. We don’t waste our time chasing yesterday’s hot money manager and we hold our mutual funds for the long term. If Meridian did nothing else but help you reinforce good investor behavior we would add enough value to justify our fees. If good behavior can add over 9% annually to your returns, it makes a lot of sense to hire a professional who can guide you through the tough times.
Table 1
Market Chasing Mutual Fund Investors Earn Less than Inflation
Time period January 1984 – December 2002
Average Investor Return 2.57%
Standard & Poor’s 500 12.22%
Inflation 3.14%
Diversified Index Portfolio 13.50%
SOURCE: Dalbar
After explaining that Meridian manages money for people using a “Passive/Index” approach they often wonder why they need ongoing monitoring and what it is that we do every day, every week, every month in managing the portfolio. The answer is that there is a lot to do even with a passive approach. What follows is a list and description of many of the tasks and activities we perform.
Fund Level Monitoring & Ongoing Due Diligence
• Current legal problems – Is the fund company being sued by shareholders, regulators, or any other group and if so why? If one of the fund companies we own is getting sued it doesn’t mean the company did something wrong, but we need to be aware of the suit and monitor it to see what it uncovers and whether or not the company is exonerated. It is rare that a fund company we own will be hit with lawsuits, but in today’s age of frivolous lawsuits even the best companies will get sued.
• Regulatory fines – Is a regulatory body currently investigating the fund company and if so why? Has the company been fined recently and if so why? Understanding the regulatory aspects of the industry and how they affect the funds we purchase is an ongoing job and one that has paid off. Only one Fund Company that we work with was named in the latest mutual fund scandals (PIMCO) and that fund was later exonerated of any wrongdoing. Our due diligence process has done a good job of eliminating companies that have had problems with regulators.
• Key staff turnover – While it is difficult, or near impossible to get to know everyone at a fund company you can get familiar with who the major players are and what they do at the fund company. By monitoring who is leaving and when and how often people leave you can get a good idea of the overall management of the fund company.
• Fees – Many fund companies charge fees that are way too high. We monitor the funds we use to ensure you are not getting gouged. In addition, many fund companies use “fee waivers” to lure you into their funds but then when you least expect it they stop waiving the fee. Suddenly you are paying much more than you anticipated – we are constantly monitoring to ensure you aren’t paying more than you should.
• Performance against benchmarks – Many of the funds we use are themselves benchmarks – other funds should be compared to the funds we use. However, it is wise to compare the funds we recommend with other indexes to see how the funds might perform differently and to ensure that we own a fund that truly tracks its asset class. In addition, we should monitor the performance of our passively managed funds against their actively managed brethren to see if our strategy is working on a short term and long term basis.
• Internal trading costs – Most people do not know it but there are costs that your mutual fund incurs that are not disclosed to you. These costs are incurred when the mutual fund manager buys and sells stock inside the fund. Many managers trade a lot, sometimes completely replacing your portfolios once, twice, even three times a year. One manager I recently reviewed replaced the portfolio 900 times annually……this costs you money. It costs money to buy and sell stocks and you are the one footing the bill. We work hard to ensure that the mutual funds we use keep internal costs low and that the trading going on is reasonable and in line with what we expect. Many experts have put internal trading costs as high as 6% annually.
• Constant marketplace evaluation – Every year new products come out, sometimes hundreds of new products and it is our job to evaluate them to see if they make sense for our clients. The overwhelming majority of new products are not good and add no value to our clients. However if we stopped reviewing new products we wouldn’t find the occasional gems. For example, Exchange-Traded Funds have been a wonderful addition in certain instances for our clients – they are a great mechanism for tax management and very cheap. We also monitor new products because we know that you will hear about them and wonder why you don’t own them, we need to have a response that is honest and reasoned.
• Risk/return relationship – The overall tradeoff between risk (possible portfolio fluctuation) and return is vital in keeping you comfortable with the investments we make. We are constantly monitoring the overall portfolio to ensure that it stays within the bounds we set up for you. We monitor it on to ensure we aren’t taking on more risk than we originally anticipated.
• Keeping portfolio in balance – When a portfolio gets out of balance it means that we have more of one asset class or less of another asset class than we originally desired. This happens when one or several asset classes rise or fall. Our job is to monitor this so that we keep the portfolio within the bounds we intended and that we don’t take more or less risk than we intended.
• Sensitivity to taxes – Many planners ignore taxes completely and put you in a portfolio that is completely inefficient. At Meridian we focus closely on how taxes affect your portfolio and make suggestions to improve the return that really matters, your after-tax return. We have many tools at our disposal to do this, including correctly placing assets into certain account types, offsetting gains with losses, using annuities when and if appropriate, and using specially designed tax managed mutual funds in situations that call for it. Many portfolios lose over 2% annually to inefficiencies having to do with not being tax smart – we seek to minimize taxes without hurting returns. Being sensitive to taxes can increase your after-tax return by 1 – 2% easily.
• Daily, Weekly, Monthly, Quarterly monitoring of asset allocation – Our systems allow us to monitor your portfolio closely to see if it is out of line with our Investment Policy Statement.
• Managing & monitoring assets across multiple accounts and account types – It is rare that a client will come to us with only one account; our typical client has 5, 6, or 7 accounts, some of which are out of control. We manage multiple accounts as if they were one, we prescribe one overall asset allocation but then we do something that many firms won’t do – we will allocate the recommended mutual funds across the accounts to ensure the funds are placed in the accounts that are best for them. We will also choose which funds are best for your 401(k). Most advisors will give an allocation and then purchase the same funds in each account in the same proportion – this gives you a situation where rebalancing can be costly and very inefficient when it comes to taxes. Allocating multiple asset classes across multiple accounts and then monitoring them can be a very difficult task; we feel that the extra work is worth it because it should lead to a higher return. We are willing to work harder and smarter to get better returns.
• Overall expenses – Fees make a difference long term. We monitor the portfolio to make sure that the overall fee is structure is reasonable and that value is being added.
• Consolidated & online portfolio reporting – Each quarter you will receive a quarterly statement outlining how your overall portfolio did. We include all assets in the report, even those that are not held directly with Meridian (such as 401(k)’s). This helps you track your return and gives you the information you need to make important decisions. Starting in the second quarter of 2005 we will be rolling out a new system that will allow you to keep track of your overall portfolio performance online.
• Financial situation (yearly process or re-running goals) – We will meet at the very least on an annual basis, but usually more often. We don’t have a set meeting time; we leave that up to you. We will meet as often as you prefer. Financial planning is not something you do once and then forget about, it is continuous. At Meridian we re-run your retirement and goal scenarios each year based upon current numbers and new or changing goals and expectations. This is one of the keys in helping you meet your long term goals.
• Monitoring what has changed with client goals – As things change in your life we need to see how those changes affect your long term goals as well as how they affect your portfolio. Regular meetings will ensure that we don’t miss anything that might affect your long range plans.
• Keeping clients on track – This is the most important part of our relationship – making sure you meet your goals.
• Preventing you from making costly mistakes – Another important job we have here is to make sure you don’t do things that would hurt your chances of meeting your goals. We help you keep fees low, not chase hot fund managers; we keep you from investing in shady ventures, and hopefully keep you from making any number of other mistakes that most people make. This alone could save you hundreds of thousands of dollars throughout our relationship.
Access to Institutional mutual funds
As a Registered Investment Advisor I am able to bypass the funds that are offered to most people and offer you funds that are managed on an institutional basis. Institutional quality funds typically have $1 – 5 million dollar minimums, though these minimums are waived for clients of Meridian. Instititutional funds have lower fees and typically lower turnover. As an added bonus client's of Meridian have access to the Dimensional Fund Advisors Institutional mutual funds. DFA is offered exclusively through pre-selected advisors who meet very stringent criteria, thought that is not the reason DFA is so good. DFA builds portfolios that are designed to specifically mimic certain asset classes and they do it in a way that no other fund company has been able to do.
Why Not Simply Buy An Index Fund at Vanguard? Why is DFA So Special?
I get this question a lot and it is a valid question. Why not simply buy a broad market index at Vanguard and avoid paying my fees. For one thing you get a whole lot more than just asset management at Meridian, as I hoped I have demonstrated. But let’s assume for a moment that the only benefit you derived from Meridian is from asset management. If you had purchased a low-cost broad market Index fund back in 1985, how would you have faired going forward versus a diversified portfolio of DFA funds, as follows:
Strategy Equity % Return*
Vanguard 100% 12.38%
DFA Portfolio 100% 14.61%
*Return before management fees
Over this 19 year period the DFA model portfolio outperformed by almost 2.25% before management fees. DFA builds a better index fund than Vanguard does. DFA has more flexibility and uses academic research to identify what stocks should be in a particular asset class, over time this leads to a more concentrated portfolio of stocks that represent an index; this should lead to a better return. In addition to a higher return the diversified portfolio had less fluctuation than did the market only portfolio. Higher returns, less fluctuation and better index tracking; that is why using Meridian and DFA is a wise idea.
Passive (index) vs. Active and Russell
If using DFA beats using an index fund strategy than wouldn’t the use active managers beat DFA and the indexes? The answer has been no. Money managers have failed to beat the indexes consistently and have failed to beat a similar DFA portfolio. To give you an example I will use the data from mutual funds offered by Frank Russell and Company to demonstrate the failure of active management. Russell is a company that specializes in picking professional money managers; their entire business is structured around the notion that by using certain search criteria and special due diligence procedures Russell can identify in advance the best managers in the world for each asset class. So how have they done compared to the DFA index model portfolios? Interestingly enough Russell has five similar portfolios to DFA’s that are called “LifePoints” and we can look at the return on these portfolios to see if they measured up to a DFA Index portfolio. The numbers cover the time period from October of 1985 to September 30th, 2004, the life of the LifePoints portfolios:
Fund Equity % Avg. Annual Return
Russell Conservative 20% 6.10%
DFA Model Conservative 20% 6.85%
DFA Annualized Out-Performance +.75%
Russell Moderate 40% 9.21%
DFA Model Moderate 40% 10.17%
DFA Annualized Out-Performance +.96%
Russell Balanced 60% 10.10%
DFA Model Normal 60% 11.72%
DFA Annualized Out-Performance +1.62%
Russell Aggressive 80% 10.60%
DFA Model Aggressive 80% 13.20%
DFA Annualized Out-Performance +2.60%
Russell Equity Aggressive 100% 10.94%
DFA Model Equity 100% 14.61%
DFA Annualized Out-Performance +3.67%
As you can see Russell portfolios consistently have underperformed their DFA model index portfolio since inception. I have the YTD, Quarter, 1 Year, 5 year, and 10 Year data and they are same, DFA beats them in almost every category over almost any time frame. How is it that Russell, who has millions of dollars of labor working everyday to find the best managers in the world can’t find managers that beat their appropriate benchmarks? The answer is it is very difficult to beat a true benchmark. Russell, the company that has built its reputation on picking money managers isn’t doing a very good job, underperforming by a wide margin over the long term. Using active managers is a loser’s game and you will most likely end up with lower returns than if you use Meridian with a cohesive, disciplined strategy and DFA funds.
Do You Only Use Mutual Funds From DFA?
For the core of your portfolio we will use DFA funds, however we also use exchange traded funds, Vanguard funds, Fidelity funds, Pimco Funds, & Cohen & Steers funds where appropriate. However the main asset classes would normally be fulfilled using DFA Funds.
The true value in working with Scott Dauenhauer and Meridian Wealth Management is not just your investment return; it is the ongoing financial planning relationship. Our clients value the ability to call whenever they have a question about something and get an honest, objective answer. They value the peace of mind that they have knowing a professional is monitoring their goals to see if they are on track to meet them. At Meridian we believe Financial Planning combined with good, prudent Asset Management will allow you to achieve your goals quicker while providing you with greater peace of mind.