[My monthly column in ACEP Now is entitled “Avoid Paying Too Much For Financial Advice.” They decided not to go with my slightly more provocative suggested title, “The Rent is Too Damn High.” While little in it will be news for those who have been reading this blog for years, it is likely to cause most of those who read it to wonder if they’re paying a fair price for their financial advice.]
What physicians should consider when hiring a financial planner or asset manager
In 2010, a former postal worker, Jimmy McMillan, famously ran for Governor of New York on the slogan, “The rent is too damn high!” That slogan can also be applied to the price most physicians are paying for financial advice. When it comes to investing, unlike with most things in life, you get (to keep) what you don’t pay for. Advisory and management fees come directly out of your investment return. Therefore, your goal should be to pay the least amount possible for good financial planning advice and quality asset management.
Jack Bogle, the founder of Vanguard, has said, “The long-term investor must be aware of the portion of investment return that will be consumed by [investment] expenses. Cost lops the same number of percentage points off both nominal and real [after-inflation] returns, but given persistent inflation, it nearly always consumes a proportionally larger share of real returns. To state the obvious, the long-term investor who pays the least has the greatest opportunity to earn most of the real return provided by the stock market.”
Consider two investors who each contribute $50,000 in the same investment, which returns 9 percent per year—before expenses—over 30 years. The first pays 0.1 percent in annual expenses. The second pays 2 percent in annual expenses. After 30 years, the first has $6 million. The second ends up with $4.2 million—30 percent less. Bogle refers to this phenomenon as the “tyranny of compounding.” Just like the “magic of compounding,” where small differences in return can result in a vast difference in wealth over many years, with the tyranny of compounding, small differences in expenses can also result in a monstrous loss of wealth.
Another way to demonstrate the importance of keeping investment costs low is to consider your portfolio withdrawals in retirement. Historical studies demonstrate that investors can take out around 4 percent of their portfolio value per year and expect it to have a very good chance of lasting at least 30 years. If investors are paying 2 percent in investment expenses, then they can really only withdraw 2 percent per year and expect the portfolio to last. If you combine the smaller portfolio value from the above example with a lower withdrawal rate in retirement, you’ll see that high-cost investors end up being only able to spend 35 percent as much in retirement as low-cost investors, or $84,000 versus $240,000.
That simple demonstration of arithmetic is enough to turn many doctors into die-hard do-it-yourselfers, but in my experience, most busy physicians would still prefer to hire an expert to assist with their financial planning and investment management. It is certainly reasonable to pay a fair price for good advice. However, that is easier said than done. “You are engaged in a life-and-death struggle with the financial-services industry. Every dollar in fees, expenses, and spreads you pay them comes directly out of your pocket,” said William J. Bernstein, MD, a former neurologist and widely recognized investing author. “If you act on the assumption that every broker, insurance salesman, mutual-fund salesperson, and financial advisor you encounter is a hardened criminal, you will do just fine.”
Your goal should be to pay the least amount possible for good financial planning advice and quality asset management.
Not every financial planner and asset manager is a hardened criminal, of course. There are plenty of good advisers out there, although they are a distinct minority among those who call themselves financial advisers. The first order of business is to make sure the advice is good. There is no price too low for bad advice. Doing a little bit of self-education and getting a second opinion are two helpful techniques for identifying bad advice. It also helps to avoid advisers who are paid on commission. You want a fee-only adviser who gets paid the same no matter what you invest in or what insurance products you buy. However, even among high-quality fee-only advisers, there can be vast differences in pricing. One well-known physician-focused firm starts its asset-management fees at 1.75 percent of assets under management (AUM). Even with a portfolio of $3 million, it still charges 0.9 percent, or $27,000 per year.
It may seem that 1 percent of AUM is the going rate for asset-management services. Many asset managers even throw in financial planning for free when you pay the asset-management fees. However, once you become familiar with asset managers who charge far less, 1 percent may start to seem rather expensive, especially for a large portfolio and especially after you apply the tyranny of compounding to those fees.
I know of several asset-management firms that charge far less than 1 percent. One charges a flat $1,000 per year, and another charges $1,800–$3,600. A third charges a minimum of $3,700 per year, plus 0.37 percent of all assets more than $1 million. A $3 million portfolio doesn’t take any more effort to manage than a $300,000 portfolio, much less 10 times the effort. So it is silly to pay for asset management as a percentage of assets, but that is unfortunately the way most of the industry works. If you choose to go with a manager who charges based on AUM, at least do the math (AUM fee multiplied by the portfolio size) to determine the equivalent flat annual fee. If you’re paying more than $5,000–$10,000 per year, it is probably worth your time to shop around.
Financial planning can also be done on an hourly or flat-fee basis. Most planners tell me it takes six to eight hours to do the process right, and hourly planners typically charge $100–$400 per hour. There is simply no reason to pay tens of thousands of dollars in ongoing fees for a task that can be done well for $1,000–$2,000, with lesser amounts in future years for minor tweaks to the plan.
When it comes to financial advisory fees, “the rent is too damn high.” Pay close attention to the fees you are paying for financial planning and asset management because every dollar you pay in fees comes directly out of your investment return.