Funds

At This Size, Your Retirement Portfolio Is Too Big For Mutual Funds

You’ve learned why it’s important to avoid investment products once you enter your retirement. If you’re lucky, you can, and maybe you should, begin transitioning your investments to individual securities well before you earn that gold watch.

“Typically, the further one gets away from owning individual investments, the higher the costs become,” says Stephen Taddie, Partner at HoyleCohen, LLC in Phoenix. “It is a function of paying for the multiple layers of responsibilities overseen by people, firms, managers, etc., as each layer creates an additional layer of fees.”

Your retirement date represents one factor that determines when you should shed your mutual funds to build a private portfolio. You also need to monitor the total value of your portfolio. It may tell you to speed up your transition, or it may tell you to wait longer before making the switch.

What’s the smallest asset size that allows you to invest in individual securities?

Previous generations had to contend with trading costs when they bought and sold stocks. This influenced their trading strategy. They wanted to avoid odd lots—anything less than 100 shares. It meant they needed a larger asset size before they could begin trading.

Today, commission-free trading is the norm. In addition, many brokers allow you to buy fractional shares. You can literally start with just $100 dollars. Still, for that amount of money, it makes more sense to buy investment products rather than invest in stocks.

“There are many advantages to investing in mutual funds or ETFs, including simplified diversification, lower minimum investment requirements, professional fund management, improved tax efficiency, and low expense ratios,” says David Rosenstrock, Director and Founder of Wharton Wealth Planning in New York City. “The smaller the portfolio size and the size of individual positions within the portfolio, the less advantageous it may be to invest in individual securities.”

Still, it’s possible to build a customized portfolio regardless of the size of your assets.

“I do not think there is a smallest size,” says Taylor Kovar, CEO at The Money Couple in Lufkin, Texas. “I have many clients with a low net worth that have held amazing individual securities for many years. This is the Warren Buffet method of investing! Buy great companies for life. I am a proponent of individual stocks and bonds for anyone that is active in the market. This means they understand the difference between stocks and ETFs and overall enjoy the markets.”

If you’re less aggressive, financial advisors offer some guidelines on practical size constraints. While they have their own methods, they tend to come up with very similar minimum sizes.

“I back into this based on account minimums for separately managed accounts,” says Eric Presogna, Owner and CEO at One-Up Financial in Erie, Pennsylvania. “For instance, Schwab offers a managed individual-stock portfolio of large-caps with an account minimum of $100,000. If a globally diversified equity portfolio consists of 40% large-caps, that means the smallest account I’d consider implementing individual stock strategies in, a 60/40 portfolio, for example, would be $420,000. If the client is taking distributions from the portfolio, the minimum account size for individual security use will likely be much higher.”

“It is generally recommended that a portfolio have a minimum of $100,000 to $500,000 in order to be comfortably invested in individual securities,” says Dennis Shirshikov, Strategist at Awning in New York City. “At this size, a portfolio may have sufficient diversification and liquidity to allow for the selection of individual stocks and bonds. For larger portfolios, it may be more advantageous to transition from investment products to individual securities as it can provide more control over the portfolio’s asset allocation and potentially offer greater tax efficiency.”

While this represents one end of the spectrum, there is another end.

At what size are your portfolio assets too big for mutual funds?

At some point, it is in your best interest to move from investment products to individual securities. Just like the minimum size mentioned above, the maximum size where you probably should move out of mutual funds is not set in stone. There are many personal factors that can determine this.

“It’s difficult to provide a specific dollar amount for when a retiree’s portfolio should move from investment products to individual securities, as this will depend on the retiree’s specific financial situation, goals, and risk tolerance,” says Mina Tadrus, CEO of Tadrus Capital LLC in Tampa. “However, as a general rule, if a retiree’s portfolio is large enough and they have the financial knowledge and expertise to manage their own investments, it may be more efficient and cost-effective to invest directly in individual securities rather than paying the fees associated with mutual funds and other investment products.”

For experienced financial professionals, it’s clear that there will come a time when you should create a customized portfolio of individual securities.

“A portfolio should no longer be invested in products and instead invest directly in stocks and bonds when it reaches a size that allows retirees to diversify their portfolios and invest in a variety of securities,” says Garett Polanco, CIO at Independent Equity in Fort Worth, Texas. “This size will vary, but it is generally recommended that a retiree have a portfolio size of at least $500,000 before considering moving away from investment products and investing directly in stocks and bonds.”

The $500,000 size has long been considered the minimum size when hiring a private portfolio manager, although it’s possible to receive personalized management for smaller account sizes. Still, the exact size for you will depend on your particular circumstances.

“Of course, expected cash flow creates some wiggle room around these figures, as contributions increase the ease of management where large continual withdrawals increase the complications of management,” says Taddie. “In practice, I think $500k is about the right level to consider for a growth portfolio using individual stocks, and $1 million is about the right level to consider when including individual bonds in the portfolio. Not many folks like to talk about bonds because they throw a wrench into things. Bonds typically trade in increments of $1,000, and while there is no visible commission associated with bond trades, a spread (difference) between the buying price and the selling price at any given moment of the day exists. The smaller the number of bonds being traded at one time, the larger the spread, and the spread is the equivalent to a commission. It is just not visible to the untrained eye.”

If you want a rule of thumb to help you determine when you should switch from investment products to individual securities, you must first identify those factors that have meaning to you.

“Overall, the size at which a retiree’s portfolio should move from investment products to individual securities will depend on their financial goals, risk tolerance, and knowledge of the financial markets,” says Polanco. “It is generally recommended to have a portfolio size of at least $100,000 before considering investing in individual securities, and at least $500,000 before moving away from investment products and investing directly in stocks and bonds.”

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