Money Makeover: Riding a wave of bad advice

It's time Jason McCann's complicated and overly expensive portfolio started to make money for him, not his planners.

By Asa Fitch, Money Magazine staff reporter

(Money Magazine) -- He's been hiking in Kauai, kayaking in Crete and on safari in South Africa, but Jason McCann is still searching for new adventures. The 35-year-old nurse anesthetist heads off on treks to far-flung parts of the world three or four times a year, often without a guidebook.

But McCann's go-anywhere style and six-figure salary have also made him an easy target for fee-hungry financial advisers. His nearly half-million-dollar portfolio is a jumble of 14 accounts, many laden with high commissions and fees.

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Recommended Mix for McCann
40% Large Caps
20% Small Caps
20% International
10% Emerging markets
10% REITS

Strategic picks:
Vanguard International Value (VTRIX)
Vanguard Emerging Mkts. Stock ETF (VWO)
Large-cap: iShares S&P 500 (IVV)
Small-cap: iShares Russell 2000 (IWM)

Case in point: the 2.5 percent annual charge on his $55,000 variable annuity. Or the 10 percent commission he paid to invest $47,000 in private REITs. Or the 2.2 percent yearly fee on the $46,000 privately managed, or wrap, account held by a financial firm in Denver.

Where he is now

McCann, who saves more than a third of his income in addition to maxing out his 401(k) and IRA, is concerned - probably too concerned - with avoiding taxes on his investment gains. He opened the wrap account with the Denver firm in 2003 because it advertised customized, tax-efficient investing, and he bought two variable annuities after a financial adviser told him they offered tax benefits.

But after paying $9,300 in fees to liquidate one of the annuities, he became suspicious of all the advice he'd gotten in the past. "I can see why some of the choices weren't the best for me," he says. Now he isn't sure what to do with the annuity he still owns.

And as a renter, he worries that he's missing out on home-price appreciation, even though mortgage payments for a very modest house in the Bay Area would likely triple his current $1,100 monthly housing bill.

What he should do

McCann's saving habits have kept his portfolio growing steadily despite the high fees, says Jennifer Cray, a financial planner in Menlo Park, Calif. But he can do better with a streamlined portfolio and a more aggressive asset allocation.

Go for tax-efficient index funds and ETFs. Cray recommends McCann ditch the privately managed account and sell about a third of his stake in the private REITs. He should direct that money into an all-stock portfolio of index funds and exchange traded funds with annual fees well under 1 percent.

"These are some of the most tax-efficient stock investments available because there's very little of the trading that generates capital gains in an actively managed fund," says Cray.

An all-equity portfolio is aggressive for someone in his mid-thirties, but McCann is a big saver and single, so he can afford to take the risk. He should keep a 10 percent stake in emerging markets funds, which have the potential for higher returns (and greater losses) than blue-chip U.S. stocks.

Make the best of the annuity. McCann pays an annual 1.4 percent "principal protection" fee on his $55,000 variable annuity, along with another 1.1 percent or so for the funds it invests in. Those costs are essentially wiping out any tax benefit he might get on the investment gains, says Cray.

But right now he'd have to pay a 7 percent surrender charge, or $3,850, to close the account. That fee decreases by 1 percent a year, so in five or six years he can exit without taking a big hit. For the time being Cray suggests he select the fund options that offer the highest possible return. They might be riskier, but he's guaranteed not to lose his principal, and the extra return could help offset those giant fees.

Keep renting. Since McCann isn't sure he'll remain in the San Francisco area for more than a few years, he should forget about buying a house for the moment. With the local housing market uncertain, he might not accrue enough equity in that time to offset the cost of buying and selling, notes Cray. Instead he can participate in the real estate market with a 10 percent REIT allocation.

That's just fine, says McCann, who has come to appreciate at least one benefit of remaining a tenant: "I like that when something breaks, I can call someone and it's fixed when I get home," he says. Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.