How many investment accounts do I really need?
Posted by Rick Fine on January 29, 2020
An overly complicated investment portfolio can have negative consequences.
Since I began working for Sensible Financial in 2003, I’ve seen many clients with numerous bank and investment accounts held in five, ten, or even a dozen financial institutions. They have individual stocks and bond, expensive mutual funds, variable annuities, municipal bonds, and real estate investment trusts. I’ve even come across a few oil well investments. It’s dizzying.
When asked how they managed to build such a varied portfolio, the most common response is, “It just accumulated over time.” They can’t remember exactly why they bought some of these holdings. Former financial advisors may have suggested new products to enhance their portfolio and they went along. The number of investment accounts grew and their advisors may not have known about all their other investments. Eventually, they contacted Sensible Financial to help with the daunting task of organizing their complex holdings.
When our team of advisors analyze a new client’s portfolio, we often find high mutual fund and trading charges on top of their advisor’s fees. These charges can add up to thousands of dollars a year. Avoiding high fees leaves more assets to invest and use for the things you want.
Another issue we see with some new clients is their account structure. Each account has the same set of securities, arranged in a nearly identical manner, and in the same proportions. This attempt at diversifying is ineffective, increases trading costs, and doesn’t fully recognize tax deferral opportunities. At Sensible, we recommend investing in multiple asset classes, not multiple accounts or financial institutions. We also recommend asset location strategies to take advantage of different tax treatments offered by different account types.
I estimate 9 out of 10 new financial planning engagements involve an overly complex and disorganized investment portfolio and account structure. Clients have lots of “stuff”, but no overarching investment strategy. In fact, we’ve found the more complicated the portfolio, the less likely there is any investment strategy.
What are the benefits of a streamlined portfolio?
Keeping the number of investment accounts to a reasonable number provides:
- Increased transparency:
If you or your advisor can’t explain each investment and how it works together with your other holdings, then you don’t have a coherent investment strategy. It’s easier to understand what you have when there are fewer accounts and positions.
- Lower trading fees:
Buying and selling many positions increases trading costs and these can add up, creating a drag on your return. Many custodians now offer $0 commission trades, but trading costs are not $0. Specifically, the bid/ask spread (the difference between the highest offer price and the lowest asking price) represents a cost. It’s more efficient to hold larger dollar amounts in fewer positions, and, where possible, hold a given security in a single account. This is not always possible, but it’s something to strive for.
- Reduced investment risk:
Managing your own investments is more challenging when there are so many holdings, accounts, and financial institutions. If maintaining a complicated portfolio becomes overwhelming, you may avoid rebalancing it. Allowing a portfolio to veer too far from its intended asset allocation can be risky in volatile markets. A more streamlined structure makes it easier to rebalance the portfolio.
How many investment holdings do I need to have a well-diversified portfolio?
The ideal number of positions depends on the amount of money you’re investing. You can have a well-diversified portfolio with a handful of low-cost, passive mutual funds or exchange traded funds (ETFs). Index funds are not the only type of passive investments, but they are the most common.
A typical mutual fund or ETF may hold hundreds or even thousands of individual stocks or bonds. If your investment holdings collectively span multiple asset classes, you can have a well-diversified portfolio with thousands of individual securities, all bundled into a relatively small number of funds.
How many investment accounts should I have?
The ideal number of accounts depends on:
- The number of employer retirement plans you and your significant other have
- How many different types of individual retirement accounts (IRAs) your household owns
- Whether you own specialty accounts, like 529 college savings plans, custodial accounts for children, such as UTMAs or UGMAs, or a Donor Advised Fund for charitable giving
In general, it is best to own fewer accounts, where each account serves a separate and distinct purpose in your portfolio. If you created a custodial account and your child has reached 18 or 21 (depending on the type of custodial account), close the account and transfer the money to your child. You can also consolidate certain accounts, like similar types of IRAs, following IRS guidelines. You can’t combine a Traditional IRA and a Roth IRA unless you plan to pay the resulting income taxes, but you could consolidate multiple Traditional IRAs, Rollover IRAs, or Roth IRAs into one IRA of the same type. You might also roll former employer retirement plans, such as 401(k)s or 403(b)s, to a Rollover IRA, especially if the IRA offers you a larger selection of low-cost investment choices. If there is an overarching rule here, it is to consolidate where possible and specialize if necessary.
To be safe, should I diversify my investment accounts across more than one financial institution?
You may have heard of the Federal Deposit Insurance Corporation, or FDIC. This insurance pertains to bank accounts. There are FDIC insurability limits on cash that is held in bank accounts. Holding your money at multiple banks if your accounts at one bank exceed these limits reduces your risk of loss in the event of a bank failure. Although the risk of bank failure is much lower today than it used to be, the fact is that banks’ primary business is lending your money to other individuals and businesses. If enough of these loans were to default in a short time period, your bank might fail. By maintaining all your accounts within FDIC limits, you will be protected should an event like this ever occur.
Brokerage firms, not being primarily in the business of making loans, are different from banks, and thus have a different insurance program. These firms carry SIPC (Securities Investor Protection Corporation) insurance. Many carry excess insurance well above the SIPC limits. These coverages ensure (subject to certain requirements) that your investment and cash holdings will be replaced if they are lost due to unauthorized activity in your accounts. (Unfortunately, this insurance doesn’t cover you if you lose money from a down market.)
You may have good reasons to hold your investments across multiple institutions. There are companies that specialize in administering 401(k)s and 403(b)s or 529 college savings plans. You might choose (or be required) to keep those funds with these specialty custodians separate from your brokerage accounts or IRAs. For most investors, spreading an investment portfolio across multiple custodians for any other reason adds a level of unnecessary complexity.
It is important to consult your financial advisor before making changes to your account structure. The rules for consolidating or moving money out of accounts are complex and can have significant tax and estate planning consequences.
Sensible Financial works with all our clients to simplify and streamline their account structure and investment holdings. Many clients find their now clearly organized account structure with fewer positions to be a major early “win.”
Simplicity makes it much easier for you to see and understand what you have. It’s also much easier to understand the reasons for your investment results. Simplicity, clarity, understanding – just from tidying things up a bit. Thanks, Marie Kondo!