by Archie M. Richards, Jr., CFP^®
May 17, 2004

Priscilla wonders whether she and her husband, ages 67 and 71, should fire their financial adviser. He charges 1.5 percent a year to manage her husband's IRA, which is worth about $1 million, The IRA contains 25 stocks, a couple of bonds, and 47 percent cash. The account lost a lot during the recent bear market. It gained only 9 percent in 2003 and is performing poorly this year. Priscilla and her husband read my column about investing in Vanguard Index funds (it's dated 6/30/03 in archierichards.com). They're not sure what to do.

Get rid of the adviser, Priscilla. In any long-term portfolio, holding 47 percent cash is ridiculous. Why pay $15,000 a year for lousy investment results?

The adviser has two objectives. His second objective is to make money for you. His primary objective is to avoid losing a lucrative client. Obviously, the fellow is pessimistic about the market. If he proves correct, he can say, "See, I told you so." If the market rises instead, he can say, "I thought it better to protect you in the face of bad news." Either way, he can maintain he was protecting your interest.

But the adviser doesn't seem to know that the stock market always contends with bad news. Stock prices are forever perched halfway between optimists and pessimists. How could they be otherwise? If the optimists disappeared, prices would fall to zero. If the pessimists disappeared, prices would rise to infinity.

Forget the pessimistic side and think long term. (At 67 and 71, assume you have at least 30 years to go.) In the long run, the market rises, because the people of the world keep generating wealth to benefit themselves and their families. I'm especially optimistic now, because technology is advancing so rapidly and because government economic policies have improved so much in the last couple of decades.

The bedrock of successful investing is diversity. You have nowhere near enough of it. Although your letter doesn't specify what stocks you hold, I'll bet you have no stocks from Europe, the Far East, and emerging nations. You should have 30 percent of your portfolio divided among those three sectors. You should have another 30 percent in U.S. stocks, divided among big growth, big value, small growth, and small value. You should have 20 percent in long-term corporate bonds, and another 20 percent in real estate investment trusts (REITs).

Investing in many sectors gives you one level of diversification. But even within each sector, you should hold hundreds of securities. These you can obtain by buying index funds, each of which is widely diversified, with rock-bottom costs and limited buying and selling.

Cash earns a pittance these days. Hold no more than 5 percent of it. I myself hold no cash in a long-term portfolio, but I probably couldn't persuade you to go that low.

The above portfolio would yield more than 3.5 percent income. From a portfolio of $1 million, withdraw $35,000 a year and have a good time. Withdraw more, if you like, and have a better time. I expect the portfolio to gain something like 11 or 12 percent a year for the next 10 or 15 years. To preserve your capital, limit your withdrawals to 6 percent a year. If the IRS requires you to withdraw more, limit your spending to 6 percent, and invest the balance outside of the IRA.

During the recent bear market, the portfolio I describe would probably have lost considerably less than your portfolio did. Stocks went down, yes, but bonds and REITs went up, softening the blow.

In 2003, stocks, bonds, and REITs all rose. You would have participated in significant advances across the board.

This year, the portfolio would probably be down modestly. So what? You can't do well all the time. Besides, the year isn't over yet. Look for favorable surprises.

Call Vanguard at 800-523-7731. Pay $500 to its financial planning department to help you get into the funds I recommended in my 6/30/03 column.

Ditch the financial adviser. He's the pits!