[Editor's Note: This post came out of an email discussion with a local financial advisor, Ryan Kelly, President of RFK Capital Management. He had done some pretty detailed digging into the required disclosures among financial advisors in Utah. Then he compiled the data. Long term readers won't be too surprised by what it shows, but the average price people are paying for financial help was even higher than I expected. The craziest thing is that the average figure is just that- an average. Half of firms charge (and half of clients pay) more! The author and I have no financial relationship.]
Last November, I read the public disclosure documents for the 53 largest investment advisory firms based in Utah. It took a long time to complete this exercise. My wife called it the ultimate snoozefest, but to me it was fascinating.
In my reading, I focused on the following two sections of each document: section five on fees and compensation, and section eight on investment strategies, methods of analysis, and risk of loss.
Having just launched my own firm, this was particularly useful to help me craft my firm’s business strategy and investment strategy. There are ten things I discovered about the industry that may be helpful for you to know. You must understand this industry to get a fair deal if you seek professional financial and investment advice.
What Is Form ADV 2?
First, what is this public disclosure document? It is called the ADV 2. The SEC website says form ADV 2 is the primary disclosure document investment advisers provide to their clients. The document is filed with the SEC and made available to the public on the SEC’s Investment Adviser Public Disclosure (IAPD) page. The document is prepared in a narrative format, written in plain English, and contains a wealth of information about the firm including the types of services offered, the adviser’s fee schedule, investment strategies, and other important information.
How I Chose 53 SEC Registered Investment Advisory Firms to Analyze
My first step was to generate a list of Utah based firms because this is my future business market. To put a limit on the time involved, I decided to only focus on SEC registered firms. Firms with over $100 million in assets under management (AUM) are required to register federally with the SEC, whereas firms with less than $100 million in AUM are required to register with their state securities division.
I went to the IAPD website (adviserinfo.sec.gov) and on the left side of the main page clicked on “Investment Adviser Data” and then clicked on the url link below “SEC Investment Adviser Report.” I then scrolled down to the “data downloads” section and clicked on the file named “Registered Investment Advisers–November 2018.”
Remaining were 53 Utah based firms with AUM above $100 million. I began reading each firm’s ADV 2 and focused on section five (fees and compensation) and section eight (investment strategies, methods of analysis, and risk of loss). I created my own spreadsheet and began inputting the information I found for each firm.
10 Things I Discovered About the (Utah) Investment Advisory Industry
#1 Average Total Fee is about 2.3% per year
I wanted to estimate the average total annual fee for investment management services. For each firm, I looked at the three fee layers: advisory fee, underlying mutual fund or sub-advisor fees, and trading commissions.
The first fee layer was easy to calculate because firms clearly disclose it. Since the advisory fee rate typically drops slightly as assets increase, I had to settle on a specific amount to compare apples to apples. For a $500,000 investment, my data suggests the average annual advisory fee charged by Utah based advisors is 1.4%.
The second fee layer, the mutual fund or sub-advisor fee, was more difficult to calculate. Most firms provide guidance in the ADV 2 on the types of mutual funds they use to build client portfolios, and so I felt I could make an educated guess on this second fee layer.
Based on this guidance, my estimate is that the average second fee layer is 0.8%. If you would like to learn more about the approach I took to estimate this, please visit my fee study article on my website: www.rfkcapitalmanagement.com/fee-study
Ryan Kelly, President, RFK Capital Management
To calculate the third fee layer (trading commissions) I took a simple approach and just assumed a 0.1% fee for each firm. This is probably too high for some firms and too low for others based on the degree of turnover for the firm's underlying investments. Every firm indicates that clients cover the cost of trading commissions and all other brokerage fees.
Thus, my estimate is that the average total annual fee is 2.3%.
#2 Americans Need a Fee Transparency Law
This 2.3% annual fee amount was higher than I thought it would be. It proved to me that Americans are “investment fee illiterate” and need a fee transparency law. We have fee disclosure, but not fee transparency.
Webster’s dictionary defines transparent as “readily understood” or “free from pretense or deceit.” Transparency comes when advisors proactively help investors understand the impact of all fees on long term investment returns.
Here’s a chart that shows the impact of high fees over 30 years.
Over 30 years, a 2.3% total annual fee on a $500,000 initial investment results in a total fee accumulation of $613,587 over 30 years. This assumes a 6% gross annual return.
Alternatively, a Vanguard Do-It-Yourself (DIY) investor can invest in three Vanguard funds (total U.S. stock, total international stock, and total U.S. bond) and pay a 0.06% total annual fee. Over 30 years, a 0.06% total annual fee on a $500,000 initial investment results in a total fee accumulation of $23,468 over 30 years. This also assumes a 6% gross annual return.
Fees have a compounding effect. If the 2.3% high-cost portfolio returns 6% gross and 3.7% net annually, then the investment will grow to $1,487,074 over 30 years. If the 0.06% low-cost Vanguard portfolio returns 6% gross and 5.94% net annually, then the investment will grow to $2,823,378. The difference of $1,336,304 in ending account balances is staggering and solely comes from the difference in fees.
A fee transparency law would require investment advisors to project total fees in dollars over an extended period of at least ten years. Advisors can easily make this calculation. For example, if an investor hires an advisor to manage a $500,000 portfolio, and the total annual fee (advisory fee, mutual fund fees, and trading commissions) is 2.3%, then the advisor would be required to produce and share with the client an illustrative table showing that total fees over 10 years will be $136,165 assuming a 6% gross annual return and 3.7% net annual return. Mutual funds must provide this information and advisors should too.
#3 – 50% of Utah-Based Investment Advisors Use High-Cost Mutual Funds or High-Cost Sub Advisor Firms
My research suggests that 30% of Utah based investment advisors use high-cost mutual funds that pay a commission (known as a 12b-1 fee) to the advisor. These are among the highest cost mutual funds available.
It also seems that about 20% of Utah based investment advisors use high-cost sub-advisors for investment management. This is essentially where the investment advisor hires another firm to do the investing. Typically, the sub-advisor charges a high fee of between 2.0% to 2.5% per year and then gives a cut of that to the advisor.
#4 – Average Total Fee is Similar Amount for National Investment Advisors, Savings Accounts, Variable Annuities, and High-Cost 401(k)s
My 2.3% total annual fee estimate is in line with the total annual fee charged by large, national investment advisory firms like Morgan Stanley, Merrill Lynch, Edward Jones, Wells Fargo, and Ameriprise. This is according to a total fee study by Personal Capital.
[Editor's Note: Is your advisor on that list above? If so, it might be worth taking a very close look at what you're actually paying and what you're actually getting and comparing it to my list of recommended advisors.]
A 2.3% fee per year is also the amount currently being levied on low yielding savings accounts. The interest paid on savings accounts at large banks is stuck at about 0.1% despite the fact U.S. treasury bills are yielding 2.4%. Banks can earn an easy 2.3% spread by paying 0.1% on customer savings and then investing those funds in U.S. treasury bills.
The industry average expense ratio for a variable annuity is 2.26% according to Vanguard. Also, there are many small company 401K plans that have total fees of between 2.0% to 2.5%. Across the board, the pound of flesh Wall Street takes in the form of fees is currently pegged at 2.3% per year.
Furthermore, it is troubling to consider that this 2.3% annual fee is higher than the current 1.93% dividend yield for the S&P 500 (as of February 2019). We know that dividends are a huge contributor to long term stock market returns, and yet Wall Street’s take is greater than the dividend yield by a significant margin.
#5 – Many Firms Believe Their Fees Are “Reasonable”
Many firms with high fees defend their fee structures. They often state that their fees are reasonable. A common phrase you will find in an ADV2 is “We believe our fees for advisory services are reasonable with respect to the services provided and the fees charged by other investment advisors offering similar services.” I found this type of statement was most common for firms whose total annual fee is above the industry average of 2.3%. The lowest total fee firms don’t seem to make this statement.
#6 – Advisory Fees Are Negotiable (Usually)
Advisory fees in the great majority of cases are negotiable. A very common phrase in ADV2 documents is “fees are negotiable depending on the complexity of the engagement.” This means that if a client’s finances are complex in nature, then the advisor will charge more.
If you like your high fee advisor and want to remain a client, then tell your advisor you want to move towards simplicity and then ask for a lower advisory fee. Your advisor will likely agree to do so. You can likely lower your fee even if you don’t ask for a shift towards simplicity.
Two months ago, I was walking in a local park and overheard two older women talking about investment advisory fees. One commented “I don’t see why my advisor charges me 1% of my assets.” I chimed in and asked “Have you asked for a lower fee?” She had recently seen the PBS Frontline special called The Retirement Gamble and that convinced her that fees in the industry are too high. To make a long story short, this woman kept her trusted advisor (who is very skilled with financial planning) and lowered her advisory fee 33%.
#7 – Fee-Only Investment Advisors Are Not Satisfied with Market Returns
I could not find a single firm among the 53 that only uses low-cost, broadly diversified index funds to build client portfolios. Maybe a few do, but they don’t offer any indication of it in their ADV2 or on their firm’s website.
The only reason you buy an actively managed mutual fund is that you think it will do better than its corresponding market index. And yet, only 7% of actively managed funds have outperformed its comparative index over the last 15 years (according to a study by S&P Dow Jones).
John Bogle, the founder of Vanguard, conducted extensive research and found strong evidence that there is a “reversion to the mean” phenomenon with hot performing actively managed mutual funds that’s been happening for many decades. Mutual funds that have historically done well are likely to lag the market going forward. He calls this “Sir Isaac Newton’s revenge on Wall Street.”
DFA stands for Dimensional Fund Advisors. DFA is a wonderful firm with a practitioner mentality, but investors must realize their entire business is based on a belief that they can do a little better than indexing, and they charge a lot for that. DFA funds are three to six times more expensive than low-cost Vanguard index funds. Their founder, David Booth, says on their website that if they can’t do better than indexing then they don’t have a business. Historically, they have in fact done a little better than indexing but there is no guarantee they will continue to do so in the future.
If you are an investor and your advisor uses DFA funds, it is essential that your advisor can articulate clearly the reason why he or she prefers DFA funds over low-cost index funds.
An advisor who uses sector ETFs is also trying to do better than stock and bond market returns. John Bogle did not like sector ETFs and preferred broadly diversified ETFs or TIFs (traditional index funds).
#8 – Many Firms Try to Time the Market
I was surprised to discover how many firms have a market timing strategy. Section eight of the ADV2 involves investment strategies and methods of analysis. There are many firms that indicate in section eight that they move in and out of the stock market.
I had an experience last month that confirmed this finding. My wife’s friend asked me to review her Roth IRA that is managed by a Utah based investment advisor. She is 30 years old and her Roth IRA has a 60 year investment time horizon. Using her iPhone, she pulled up her account statement and I was shocked when we discovered that 100% of her Roth IRA was invested in a high-cost bond ETF. I advised her to ask her advisor why she is 100% invested in a bond ETF when she doesn’t plan to touch the money for at least 30 more years. Her advisor said the firm uses an investment consulting firm to make calls on when to get in and out of the stock market. In October, the firm suggested getting out of the market which is why her Roth IRA moved out of a stock ETF and 100% into the bond ETF. As of January 31, her account was still 100% invested in the bond ETF. The firm got out of the market at a good time in October, but did not get back into the market at the right time and has missed the recent market rally. I assume they will continue to play this game for the next 60 years of her investment lifetime.
Regarding fees, the bond ETF has a 0.5% expense ratio and she is being charged a 1.9% advisory fee for a total annual fee of 2.4%.
I showed this friend several YouTube clips of John Bogle talking about the principles of long-term investing success. We talked about the wisdom of not trying to time the market which is just short-term speculation, and the need to keep costs low. She quickly agreed. I helped her open a Roth IRA at Vanguard and she is now a DIY long-term investor and is invested in three simple index funds (50% in Total U.S. Stock, 30% in Total International Stock, and 20% in Total U.S. Bond).
I have shown her YouTube clips of John Bogle encouraging investors to “stay the course” and advised her to do the same. Her total fees are less than 0.06% per year. The fee savings over the next 60 years will be in the several hundreds of thousands of dollars and she will earn her fair share of global stock and bond market returns.
#9 – Many in the Industry Have Vast Experience with Financial Planning
#10 – The “No Man Can Serve Two Masters Problem” Means We Need Flat Fee Investment Advisors and Advice Only Financial Planners
In this industry, it is not the financial planning side that is broken. Rather, it is the investment management side that is broken.
I recently read the book “John Bogle and the Vanguard Experiment” by Robert Slater. It is an out of print book that tells the amazing story of the founding of the Vanguard Group. The short version of the story is that Bogle realized there is a “no man can serve two masters” problem in the mutual fund business. Basically, what is good for the mutual fund investor is usually not what’s good for the management company’s shareholders. High profits for the management company’s shareholders mean low profits for the mutual fund investor, and vice versa.
Bogle found a structural solution to the “no man can serve two masters” problem. In the case of Vanguard, he formed an investor-owned mutual fund company where any profits would go to lowering the expense ratios of the Vanguard mutual funds. There would be no outside shareholders. Vanguard’s unique structure is why the mutual fund industry is continuing a fee war that is driving down the cost of mutual funds, and why Vanguard is bulldozing over “for profit” mutual fund companies and will likely continue to do so.
John Bogle solved the conflict of interest problem from the top at the mutual fund level. We now need investment advisors to solve the conflict of interest problem from the ground level. Just like with Vanguard, there are structural solutions. How can an investment advisor solve the “no man can serve to masters problem” at the investment advisor level? The two structural models that seem to solve the problem (or greatly minimize it) are flat fee investment advisors and “advice only” financial planners like Sarah Catherine Gutierrez at Aptus Financial.
I believe Sarah’s advice only model has tremendous disruptive power to lower costs and increase efficiency in the investment advisory industry. With this model, the advisor provides the client with the tools needed to be his or her own investment manager. This can include:
- Educating the client on timeless investment principles
- Writing a specific financial plan for the client,
- Helping the client open the necessary accounts
- Execute the index fund trades
- Providing behavioral coaching along the way.
I predict that in 20 to 30 years Sarah’s impact on the entire investment advisory industry may even approach John Bogle’s impact. I recognize this is quite the statement to make. The reason I believe it is that her model has the potential to lower excessive fees in our financial system to the tune of hundreds of billions of dollars every year. It also has the potential to make millions of Americans more effective DIY investors who invest based on the timeless investing principles of broad diversification, low costs, tax efficiency, and long term discipline.
My firm is currently beta testing a DIY investing service. During the beta test phase, our clients get a personalized financial plan (written in a narrative format), an investment plan, and assistance in becoming an effective DIY investor for a $800 flat fee.
This model minimizes conflicts of interest. Conflicts of interest in this industry can never be eliminated, but they can be minimized. It is a “fee for service” model rather than a “money on money” model. It empowers the advisor to become a true fiduciary and offer unbiased, unconflicted advice. It saves the client/investor an enormous amount of money over an investment lifetime because fees are only paid when financial planning and investment advice is given.
It does not mean the advisor makes very little money. Low-cost index funds and advisors can co-exist. The advisor can still make good, reasonable compensation. However, it demands that the advisor manage his or her firm more efficiently and become a true practitioner with both financial planning and investment advice to build his or her value proposition.
Lowering the total fees draining from our financial system will result in better retirement outcomes and a more efficient financial system. The spread between gross return and net return for investors will narrow. It’s high time for all American investors to get their fair share of future stock and bond market returns. Firms that focus on “structure” and minimizing the “no man can serve two masters problem” will lead the way in this revolution.
What do you think? Have you ever read an ADV2 form? What do you think about the future of the investment advising industry? Comment below!
What an interesting post! Those fees are much higher than I anticipated, too. An average fee of 2.3% is highway robbery. There is no way they are making that up.
There is a reason I talk about a gold standard to financial advising. And it is because of the lack of transparency (outside of the fine print in th3 ADV brochure) that exists in the industry.
And, I completely agree that Aptus is changing the way people do business. I hope that they continue their disruption.
TPP
That was pretty remarkable analysis and thank you for doing it. It is especially refreshing coming from a financial advisor.
I love the “no man can serve two masters” reference because it really is true. It is hard to be a true fiduciary when that act will lower your own income.
That 2.4% cost of dealing with financial advisors in the firms you analyze was way higher than I expected as well and the fee drag on your overall portfolio reflects what the actual cost over decades of investing will be.
Best of luck with your beta testing and it is nice to see that some financial advisors are starting to come around and put their client’s best interests first.
Awesome post.
Thanks for the links to the ADV form search. When an advisor approaches me I have been asking them for their ADV. They usually don’t follow up with me after that question. I can’t wait to dig into my local firms and advisors.
Now I see why. This is fascinating data. Not a snoozefest at all (although my wife would agree with yours).
It is more like watching a horror movie.
Among physicians, I know there are multiple problems when it comes to investing.
1. They are too trusting. They assume all professionals are honest, smart, ethical, and doing right by their clients the way we do for our patients.
2. Fee transparency wouldn’t help them much because “What’s one or two percent?” It doesn’t sound like much to them. That goes back to your point about financial illiteracy.
3. They are smart and outperform others all the time. Why couldn’t they find an advisor who outperforms their peers? How hard can that be?
Those are tough obstacles to overcome. Your analysis is one step in getting us there.
So I agree with this post. One counter-point though is affluent investors often at least consult with an advisor. Some of the benefits are psychological. If an advisor can talk me off the ledge in 2009 when I’m about to sell all my stocks and go to cash, they earn all their money and more even if I’m investing in only Vanguard index funds.
To that last point, Wealthy Doc, there is indeed real value in advisors saving us from our worst cognitive biases. That being said, there should be MUCH less expensive ways to find someone to talk us out of our worst impulses. Maybe we should run a Dumb Investment Impulse Hotline that anyone could call when they feel the need to sell based on fear or buy based on greed, ha!
What a great post. Seriously. This is the kind of work that needs to be done to show us with cold, hard facts how people are throwing their money away when they use these high-fee advisors. Kudos for a wonderful investigative report – one of the good guys!
Exactly why I stopped using my advisor. . Advisory fees over 1% plus hidden fees of DFA funds. It adds up. No wonder that firm had luxury boxes at the stadium.
For the fullest transparency, you could suggest considering the future value of the $800, right? When comparing the flat fee investment advisor option. I am a newish out of residency dr at the earliest stages of learning about DIY investing and have no idea what I’m doing but it would make sense to me to consider the $800 fee as an additional $4500 future dollars in the comparison bar graph. Which I actually think is more persuasive that a flat fee is a better deal long-term even though $800 compared to a 1% advisory fee might sound less appealing in the moment. Super interesting article, thanks for sharing!
Diana,
That’s a good and fair point. For young clients who pay $800 for my DIY Investing Service, it could certainly cost them $4,000+ in “future dollars” due to compounding — that’s something I should mention to promote full transparency. I guess that’s true of anything that a young person spends money on as expenses mean fewer dollars earning a rate of return. Thinking of current expenses this way is good for long-term financial health!
Excellent post. But I do have a bone to pick with this statement…
“The craziest thing is that the average figure is just that- an average. Half of firms charge (and half of clients pay) more! “
What bone would you like to pick? The radius? The tibia? The mandible?
Median vs mean and confusing the two, I assume.
Ahhh….excellent point. Not particularly important to the argument, but some people are in to those things. If you don’t like “half” replace it with “a lot of”
Dr. Dahle, I checked my fee spreadsheet. Turns out median and mean are almost the same.
26 of the 53 firms have an average total annual fee above 2.3%. A few are above 3.5%!
I’d love to see a histogram of the fee distribution if you can create it easily.
Send me an email and I’ll reply back with a histogram of the fee distribution.
[email protected]
Ryan, this was a great post and I would say that even if you didn’t say nice things about Aptus, ha! From a public policy perspective, we think fee transparency would help. More importantly, though, folks just need to be cynical about investment advice. You cannot blindly outsource your financial life to someone else. Whether you DIY your investments or not, you have to self-educate so you at least have a finely-tuned BS detector.
Thanks Tim! I think it was Dale Carnegie who said “criticize by category, praise by name.” Happy to praise by name your firm — you and your team are pioneers.
How do you open the file listed in this article? Even my practice IT guru is having problems.
Which link/file are you referring to?
” IAPD website (adviserinfo.sec.gov) and on the left side of the main page clicked on “Investment Adviser Data” and then clicked on the url link below “SEC Investment Adviser Report.” I then scrolled down to the “data downloads” section and clicked on the file named “Registered Investment Advisers–November 2018.”
Hi Eric,
Send me an email with your phone number and I’ll call you to help you troubleshoot that on the SEC website.
[email protected]
This excellent ‘investigative report’ somehow missed the opportunity for a much better title. “Clickbaity” is usually one of WCI’s hallmarks. I almost walked by it due to the title (OK, I guess I’m still a sucker for the word ‘millions’). With an average of 2.3% , “highway robbery” comes to mind. Perhaps Jim and Ryan are trying not to call out the investment management industry too transparently? How about “Time to wake up! Your investment manager may be walking away with your millions.” or “What are you paying for investment management? (Hint: It might be millions)
I’ll tell Jill and Ryan their title sucks. 🙂 Usually top ten lists are pretty clickbaity though.
Ha ha, the original title I submitted was “10 Things I Learned Reading 53 Public Disclosure Documents”. That’s a snooze fest right there. I could never be hired writing newspaper headlines!
WOW I haven’t even made it to the data- I just reviewed the ADV2 and the recent reported investigation/sanctions on the advisor group I currently use:
(Below in all CAPS is copied from ADV2)
“THE COMMISSION FINDS THAT THESE PROCEEDINGS ARISE OUT OF BREACHES OF FIDUCIARY DUTY AND INADEQUATE DISCLOSURES BY THE RESPONDENT IN CONNECTION WITH ITS MUTUAL FUND SHARE CLASS SELECTION PRACTICES AND THE FEES IT RECEIVED. AT TIMES DURING THE RELEVANT PERIOD, RESPONDENT PURCHASED, RECOMMENDED, OR HELD FOR ADVISORY CLIENTS MUTUAL FUND SHARE CLASSES THAT CHARGED 12B-1 FEES INSTEAD OF LOWER-COST SHARE CLASSES OF THE SAME FUNDS FOR WHICH THE CLIENTS WERE ELIGIBLE. RESPONDENT RECEIVED 12B-1 FEES IN CONNECTION WITH THESE INVESTMENTS. RESPONDENT FAILED TO DISCLOSE IN ITS FORM ADV OR OTHERWISE THE CONFLICTS OF INTEREST RELATED TO (A) ITS RECEIPT OF 12B-1 FEES, AND/OR (B) ITS SELECTION OF MUTUAL FUND SHARE CLASSES THAT PAY SUCH FEES. DURING THE RELEVANT PERIOD, RESPONDENT RECEIVED 12B-1 FEES FOR ADVISING CLIENTS TO INVEST IN OR HOLD SUCH MUTUAL FUND SHARE CLASSES. AS A RESULT OF THE CONDUCT, RESPONDENT WILLFULLY VIOLATED SECTIONS 206(2) AND 207 OF THE ADVISERS ACT.”
The final judgment- just shy of 1 million dollars:
“RESPONDENT IS CENSURED, SHALL PAY DISGORGEMENT OF $835,375.37 AND PREJUDGMENT INTEREST OF $89,647.86, AND SHALL COMPLY WITH THE UNDERTAKINGS ENUMERATED IN THE OFFER OF SETTLEMENT.”
Needless to say I am working towards a new advisor.
This is both scary and interesting. I’m working on a follow-up study and would be interested to interview you for that — I’m trying to get “real life” examples of how the ADV 2 can help people make better decisions in selecting an advisor. Please feel free to email me: [email protected]
(*I won’t pitch you on my own service—just want to ask you a couple questions for my follow up article)
Follow up email sent.
They paid a DISGORGEMENT? Now thats a cool word I’ll probably never be able to use. Nice post Ryan I am somewhat tempted to look up my local shysters..
Saved another one.
Yes you have. Last year after meeting with our adviser my wife asks me “How much to we pay him?” and so it began. Thank you for this website, your books and your Fire Your Financial Advisor program.
Greg
@ACMD
“Needless to say I am working towards a new advisor.”
Why not just do it yourself? You’re here. You’re literate.
Solid work. And great business strategy.
Thanks Ryan, great post. Very informational. If this doesn’t convince Docs to get smarter with their investing, nothing will!
I would also contend that the Financial Planning side of the business is also broken. Too many advisors defend their fees (and underperformance relative to index benchmarks) as “planning” when in fact most planners just crap out a Monte Carlo simulation once a year, slap a logo on it and call that planning.
A robot can do that for basically free. And the rate of machine learning (AI) will and should put most mediocre planners out of business.
I think that’s a valid point. I do believe any advisor who proactively minimizes conflicts of interest (through an advice only or flat/reasonable fee model) and also fully embraces index funds is empowered to become much better at financial planning. If an advisor admits that the index fund is the greatest financial innovation of the last 100 years, and that managing a portfolio of index funds is simple, then the advisor will shift his focus to financial planning. That’s where value can be added through expertise and good judgement.
Interesting exercise. But the author does a real disservice to “asset class investing“ in general and using DFA Funds.
Investors are much better off holding a portfolio that is well diversified and tilted towards smaller and more value-oriented stocks than basic (market weighted) index funds. DFA does this much better than index funds or ETFs. The long-term evidence is clear on this and its importance dwarfs small differences in fund fees or advisor fee differentials.
Case in point: the 2000-2009 “lost decade” (Vanguard Total Stock Index = -0.4% per year, DFA Equity Balanced Strategy = +6.7% per year).
The long-term evidence is that small/value stocks beat the market by the same magnitude and by the same persistency as stocks beat 1-mo t-bills (see Fama/French “Volatility Lessons”)!
As for 1% advisory fees, it’s a mistake to assume a DIY approach will yield the same gross-of-fee return as an adviser portfolio (and 1% higher after fees) because it ignores behavioral costs — positive for advised investors and negative for DIYers.
Morningstar found that investors using an advisor w/an asset class investing approach using DFA Funds beat DIY indexers in the behavior department by over 2% per year!
Net of 1% yearly fees, advised clients still come out on average by 1% per year before considering higher expected portfolio outcomes and less time spent on finances (a huge benefit). See here: https://www.fiscalisadvisory.com/assets/pdfs/indexing_goes_hollywood.pdf
Wrong tense again. You’ve made this mistake before. You should have said “investors WERE much better off holding” a tilted portfolio. In fact, that is not the case for the last few years. Over the last 15 years, Large Growth has outperformed Small Value by 9.37%/year to 8.81%/year.
http://performance.morningstar.com/fund/performance-return.action?t=VIGRX®ion=usa&culture=en_US
http://performance.morningstar.com/fund/performance-return.action?t=VISVX®ion=usa&culture=en_US
5 year outperformance is even more impressive (5% a year!)
WCI – let’s clarify where your comments. You really need to read the Fama/French research paper I referenced above.
3-5 (even 10) year periods of underperformance for stocks vs bonds AND small/value vs large/growth are not unheard of. They happen with about the same magnitude.
Small/value has underperformed over last few years as the stock premium over bonds has been above average. From 2000-2009 stocks trailed t-bills but small/value had far above average premiums. Exactly what you want to see. That’s very important diversification.
Of course, almost no individual investors are well versed in this stuff. All the more reason why a good advisor can be an excellent investment. Just imagine the DIYer bailing on small/value asset class diversification today or the tail end of the 1990s. A lifetime of advisory fees in missed out on returns in just a few years. Now there’s a blog worth writing.
I’m quite familiar with Fama/French’s work. We’ve sparred on this before. It is based on back testing of a limited data set. Be careful how much faith you put into it. I believe it enough to tilt some to it, but I’m careful not to tilt more than I can handle the tracking error. It would not surprise me, however, if I looked back in 30 years and found out that neither the small nor the value factor were real and were just an aberration in a limited data set.
It’s certainly not a “small differential” in fund/advisor fees. A DIY Vanguard investor can build an asset-class based portfolio and keep total expenses at less than 8 basis points per year. An investor using DFA Funds with an advisor will pay 140 basis points per year in total expenses. 40 basis points to DFA and 100 basis points to the advisor. That 140 basis points on DFA’s $650 billion in AUM is $9.1 Billion per year in total fees. For Vanguard DIY investors, 8 basis points on $650 Billion in AUM would be $520 million per year in total views.
1 year differential = $8.58 Billion.
Also, I think the WCI readers are building long-term discipline with their investing and many don’t need behavioral coaching. If they do need a little coaching, they can pay an hourly advisor for guidance and save a lot of money versus paying a 1% annual fee.
meant total *fees, not total views 🙂
Ryan, Not quite. You’ve got to dig a little deeper.
Vanguard (and ETFs) aren’t available in many core asset classes in the int’l & EM small/value space, and where they are available (mostly US), they’ve trailed DFA by 1-2% a year over the long term in most cases from less than optimal small/value exposure, NET of differences in fund fees. So the fee differences hide higher net-of-fee returns from better (and more complete) asset allocations and superior implementation.
Further, there’s no way an individual, on their own, after reading a few blogs, is designing and managing/sticking to a growth-oriented asset class portfolio through downturns (2002, 2008, etc.) and periods of tracking error (1995-1999, 2014-2019, etc.). An hour of consulting with a random advisor who hasn’t been guiding them along the way isn’t likely to help much either.
Just see WCIs post above where he’s seriously doubting the existence of future asset class premiums — making the common mistake of falling victim to small sample sizes (ignoring The Law of Large Numbers). Bad behavior is a significant hidden cost, almost all DIYers suffer to some extent, which a good advisor can reverse, saving an investor another 1-2% per year of missed out returns.
Finally, let’s not forget hiring an advisor saves you significant time, energy, and stress/anxiety compared to DIY. Hard to put a % on that but it’s a huge emotional benefit.
I have no more doubt now than I had 10 or 15 years ago. And yes, I’ve maintained the same tilt throughout. We’ll see if it pays off over my investment horizon.
A better portfolio can potentially pay the entire advisor fee. Planning, behavioral counseling, added free time and peace of mind? All “free”
(1) 70/30 Vanguard Total US Index/Total Int’l Index
(2) DFA Equity Balanced Strategy
5/1998 to 3/2019
(1) +6.3%/yr
(2) +8.6%/yr
DIFF = +2.3% per year
2000-2009 “Lost Decade”
(1) +0.6%/yr
(2) +6.7%/yr
DIFF = +6.1% per year
This is such important, but sadly unknown, information. Investors would be so much better off learning the whole story and not falsely believing “fees are all that matter.” The evidence is overwhelming to the contrary.
You sure are willing to trot out that “lost decade” and isolate it out but not the last decade which shows exactly the opposite.
Unfortunately, what we really need to know to make a decision is what the next decade will show, and that information is unfortunatley unavailable. So you look at the past data, you understand the various theories, you make your bets and you take your chances.
I invest in both Vanguard and DFA funds. I actually have a Vanguard vs DFA experiment running head to head in my kids’ 529 accounts. After 4-5 years, Vanguard still leads significantly, and that’s in DFA’s marquee asset class.
Great piece with great lessons. You deserve a medal for reading 53 form ADVs!
Thanks Allan!
Shoot, you get a medal for 53? I bet I’ve read hundreds over the years. Super helpful to quickly weed through advisors.
OK-you get the gold medal. You may have read more than any regulator. How did mine look? I must be doing something wrong as I keep getting fired after every engagement. I’ve got the worst client retention of any advisor!
I’m sure I’ve read yours at some point in the last decade. I certainly would have approved you to advertise on the site. Too bad you don’t need to.
Allan, I’m imagining a future day when Morningstar begins rating independent investment advisors. The analyst write up for your firm: “Wealth Logic recieves a one star rating for the client retention pillar. More than 99% of clients fire Allan Roth after the very first engagement. This is of great concern for anyone considering Roth’s services.”
Cute Ryan. Imagine the AMA writeup of a doctor where the patient shows up in the emergency room and the doctor fixes him up but refuses to discharge him so he can keep charging the patient for a decade or more.
BTW, I suspect Morningstar would be fine with the hourly (fee-for-service) model and boring low-cost diversification and rebalancing rules or a one-and-done consulting engagement.
I think Morningstar would be just fine with that :). Would they create a new “assets under advisement” figure for advice-only/hourly advisors? If so, you’ll have the largest “AUA” of any advice-only advisor!