By Dr. James M. Dahle, WCI Founder
I find it astounding to realize just how much a financial advisor can cost you over the course of decades. I suspect you will too by the end of this post. For the purposes of this post, let's assume an advisor provides no value above and beyond what you could do yourself. Now, this probably isn't true. Most advisors provide at least a little bit of useful financial education to their clients. They may teach them a little about investments, or the markets, or budgeting. They encourage the client to save a higher percentage of his income, and when the inevitable down markets come, they may keep the client from selling out at the bottom.
This service, even if the advisor does nothing else, may be worth their high fees. Not to mention the benefits of “not having to worry” about your finances, not having to spend the time to do little portfolio management tasks, and not having to learn anything about investing (if only this were the case). There is a certain value there. Of course, many “advisors” give such poor advice that you may be better off without it, not including their outrageous fees. We'll ignore that as well.
The Cost of Using a Financial Advisor
1% Advisory Fee Isn't Much, Is It?
For our first example, let's consider a quality advisor who charges just 1% of the portfolio a year. Let's compare him to a do-it-yourself investor who holds the same portfolio and achieves the same after-tax return of say, 5% real (after-inflation). Let's say they both invest $50,000 a year for 30 years. How much more will the do-it-yourselfer have after 30 years?
We see that at the time of retirement, the do-it-yourselfer has $3,488,039. The doctor using the advisor has only $2,916,417. Using an advisor has cost the doctor almost $572K, or about 16% of his retirement stash. Divide that out by 30 years, and we're talking about $19K a year for advisory services.
Fee-Based Advisory PLUS Commissions
Now, let's say the advisor is “fee-based,” meaning he takes 1% AND sells you loaded mutual funds. So 5.75% of every dollar the doctor invests goes to the advisor right off the bat. Loaded funds tend to also be high expense funds, so let's assume they perform about 1% worse a year than the funds the do-it-yourselfer chooses. Now, what is the difference after 30 years with a fee-based advisor and loaded funds?
Now we see that the financial advisor has cost the doctor $1.2 Million dollars ($40,000 a year), or about 34% of her retirement nest egg. And this makes the rather weighty assumption that the advisor never churns the account. If he swaps out loaded mutual funds every couple of years as many do, this physician is never going to get anywhere. That's basically the equivalent of paying the advisor ANOTHER 3% of your portfolio a year.
What About the Advisor's Account?
Well, let's assume the advisor is smart enough to invest his earnings from you. Since he doesn't have to pay an advisor or use the crappy funds he's recommending for you, he can make 5% a year, just like the do-it-yourselfer. How does he make out?
Now you can see what's going on. Money is being gradually transferred from your retirement portfolio to his. Although he has “helped” you grow your portfolio to $2.28 Million, he has also grown his to $724K. How many clients like you does he really need? Not very many. Remember, this assumes that after the initial purchase, all funds are held until retirement so no ongoing loads other than the new money invested.
Paying the Advisor Throughout Retirement
To make matters worse, you don't stop investing at retirement. Let's see what happens if you keep on investing with this guy (or likely his son) throughout your retirement, say, another 30 years. Now let's say you need $100,000 a year from the portfolio to live on during retirement.
The doctor using the advisor got to spend $3 Million in retirement and left his heirs $645K. Not too bad. Of course, in the end, it looks like the advisor ended up with more of the portfolio than he did—$4.35 Million. Meanwhile, the do-it-yourselfer was able to spend that exact same $3 Million, and leave his heirs a whopping $8.1 Million. Alternatively, he could have spent TWICE as much in retirement each year, and STILL left his heirs $1.1 Million—almost twice the inheritance. The cost of advice can be high indeed.
So when you make the decision about whether to use an advisor, or whether to do it yourself, realize that this decision could cost you millions of dollars over your lifetime.
More information here:
If you still prefer using an advisor, check out the list of recommended advisors to find someone who gives good advice at a fair price. If you'd prefer not to spend millions for financial advice over the course of your lifetime, get started learning how you can easily do this yourself with a good investing book or two.
What do you think? Are financial advisors worth the cost? How much do you think you should pay for good financial advice? Comment below!