I thought I would share two emails I received in a 24 hour period earlier this year. They are very similar to other emails I get multiple times a week and demonstrate very well why I believe paying commissions is the absolutely worst way to pay for financial advice.
My Least Favorite Way to Pay for Advice — Commissions
Lots of advisors I interact with like to discuss the intricacies of and the possible rare needs for financial products like cash value life insurance. But they don't see the damage being done by financial salesmen masquerading as financial advisors. These emails demonstrate that problem better than anything I could possibly write:
Email # 1
I am a hospitalist; I love your website and have learned A TON from your posts about investing. So my question is regarding a front load SEP-IRA (my wife's) and my Roth IRA (also filled with front-loaded mutual funds) we have through Northwestern Mutual vs. doing stuff on my own through Vanguard. My financial guy (CFP) is telling me that in the end I will make more with front loaded mutual funds (about 4%) vs. a Vanguard fund (he says they charge 1% a year on the fund which I cannot find anywhere on their website). I think he is just trying to stop me from
transferring all my money to Vanguard. What do you think?
Email # 2
First of all I want to thank you for what you do. It's because of you that so many thousands of professionals have a firmer grasp of personal finance and the steps they need to take to ensure fiscal health. I first got turned on to your blog a few months ago by a colleague, and the knowledge I have gained as a result is beyond measure. Here's an example of how I personally have benefited. As many others, I am a victim of unscrupulous financial planners. Toward the end of my residency in Anesthesiology, we were approached by a couple of financial advisors who had arranged to hold a seminar/sales pitch at our hospital after hours.
How they were even allowed to do this is beyond me, but there they were, extolling the virtues of their services as “specialists in physician financial management”. Wanting to get started on retirement planning, but not having a plan in place, I signed on. And there began the pouring of my money into high load mutual funds and life insurance.
The funny thing is, from the beginning, I never fully trusted them, and constantly wondered if their guidance was really in my best interest. But with my complete lack of financial literacy, I wasn't able to validate those suspicions. Worse, I didn't even know how to go about investigating the question! And anytime I did manage to feebly inquire why they had me in these high cost mutual funds with 5% loads at Fidelity, they always had slick (and confusing) answers that I had no power to comprehend, let alone refute.
Then when I had built up enough of a portfolio, they moved me to “cheaper” institutional funds where each fund had an ER in the 1.5-2.5% range AND an additional 1.1% fee for all AUM. But, finally, after reading your blog and some of the selected works you recommend, I gained the confidence I needed to dump those advisors, liquidate my funds and move them to Vanguard, and come up with my own asset allocation and investment plan.
As a result I've already saved hundreds if not thousands in unnecessary fees, and I finally feel like I'm in control of my financial future. Anyway, I know that's a long story but I wanted to illustrate just how helpful you've been to me and I'm sure many others who come out of residency both very competent practitioners and very lousy stewards of their money. NO MORE!
But I do need some advice on one other remaining problem and I'm hoping you're willing to provide it. The other way these guys screwed me is by getting me into an indexed universal life policy. I started paying into it in October 2010. So far, as of this month, I've paid 33,800 in premiums, and my cash value is 31,427. The surrender value is 25,894. So during the last 4.5 years, while we watched the stock market's meteoric rise, I ended up thousands in the negative, and I lost out on a real opportunity for gains that I may never see again.
As perfectly exemplified by the experience of these doctors, the very worst way to pay for your financial advice is through commissions. If you do so, you are likely to be receiving bad advice, and probably at an unfair price. The worst financial products pay the best commissions, so the advisor, even if he were competent, is facing a terrible conflict of interest. However, most of these advisors have had little to no training, and the training they have had is in sales. The bottom line? Don't pay for your financial advice using commissions or you're likely to end up like these docs, paying loads, high expense ratios, and commissions on lousy mutual funds and life insurance policies and maybe even an additional Asset Under Management (AUM) fee.
The Second Worst Way To Pay For Advice — AUM fees
Speaking of AUM fees, I consider this the second worst way to pay for advice. It's not as bad as commissions, since the advisor is being paid directly by you and only for their advice and service. So it is truly fee-only, but there are still five significant problems with this model.
5 Problems With the AUM Fee-Based Model
# 1 Conflicts of Interest
Paying commissions and AUM fees is never any fun. Add yours up to see if you'd be better off with an hourly or flat-fee advisor.
You still have a conflict of interest. The advisor gets paid only for money under his management. So if he's not managing your 401(k), but is managing your IRA, he may advise you to do a 401(k) rollover, even if you're in a great 401(k) or maybe should be doing backdoor Roth IRAs (and thus don't want a tax-deferred IRA.) The advisor is also more likely to recommend against paying down student loans or mortgages. Not to mention investments managed by someone else, like real estate.
# 2 AutoPay
AUM advisors generally withdraw their fees from your account rather than asking you to write a check to them. Being “out of sight and out of mind” has the effect of you being anesthetized a bit to just how much you are paying. If you actually have to consciously pony up the cash every year, you might be more likely to negotiate, move on to a lower cost advisor, or learn to do it yourself.
Paying AUM fees doesn't have to result in higher fees than paying an annual retainer or an hourly rate, but too few investors with advisors ever really add up all the fees to see just how much they're paying. Advisors don't like clients who do that sort of thing. They'd much rather fill their client rolls with nice “price-insensitive” doctors who feel they're too busy to deal with “the little stuff” and love how the advisors tell them how important they are and how valuable their time is. Meanwhile, the advisors are laughing all the way to the bank.
They wouldn't even think about working for the mere $100-300 an hour that the doctor is working for. Doctors think the advisors are the “hired help” when in reality, it's just the opposite. The best-paying jobs, and certainly the jobs with the highest ratio of income to education/training required, are owning a business that manages other people's money. AUM advisors might argue that investors really want their fees out of sight because it is psychologically too painful to pay them up-front, and if they quit paying them, they'll be worse off due to their behavioral mistakes. I find that patronizing, although it may be true for many investors with little knowledge and poor discipline.
So why do advisors try to specialize in doctors? Because doctors have money. But guess what? They don't look at all doctors the same. They would much rather advise an orthopedic surgeon than a pediatrician. The capitalist in me knows why. If I were an advisor, I'd charge AUM fees and find as many highly paid specialists as I could find to advise. The capitalist in me can easily see it is a great business decision. But the consumer in me can't help but cry “Foul,” or at least, “Caveat Emptor.”
# 3 High Minimums
Another issue with AUM advice is that the advisor has very little incentive to help you with your money when you don't have much money, which is precisely when you can benefit most from good advice. Minimums are often as high as $1 Million, but almost always at least $100-500K. If a flat annual fee or an hourly rate is good enough when your assets are under $100K, they should be good enough when you have $10 Million.
# 4 Rates Come Down Too Slowly
It simply doesn't take twice as much time and effort to manage $2 Million as $1 Million. Some advisors seem like they're lowering costs by offering to manage that second million at 0.9% instead of the 1% they charged on the first million. But come on, that means you're charging $19K a year instead of $20K a year. Some discount. If they really wanted to charge a fair price, they'd charge 1% on the first million and 0.1% on everything above that.
Speaking of decreasing rates, you always want to be sure exactly how that advisor is charging for the “second million.” Is the fee 1% of the first million and 0.75% of the second million, or is it 0.75% of EVERYTHING once you have over $1 Million. It's different for every advisor, so be sure you check.
# 5 You're Someone Else's “Great Investment”
I had a fee-only advisor remark to me that “AUM fees are the best kind of passive income.” Well, do you really want to be somebody else's best investment? He's right, of course. The income comes in year after year after year, gradually increasing, while the work required goes down as the years go by. Most investment plans are eventually pretty automatic. Even if the advisor has to do some hand-holding during a bear market every 5 to 10 years, no big deal.
So, while paying AUM fees is far better than paying commissions, I'd much rather see doctors paying an annual retainer for investment management and hourly rates for financial planning. I probably wouldn't pay an AUM fee at all, but I certainly wouldn't do so without adding them up so I could compare them to a flat-fee or hourly advisor.
What do you think? How do you pay an advisor? Do you like that method? Why or why not? Comment below!
Excellent article… I went to a fee-only advisor who was using the AUM model and the first thing he told me was – “stop contributing to your 401K and put all of it into a taxable account now as the tax rates are going to rise in the future”.
Luckily for me I was getting deeper into the WCI website and learning stuff that it was easy to walk away.
I just do everything by my self and go online (Boggleheads, email WCI) for any questions/clarifications. I could not be happier!
That is a poor adviser, not a result of the AUM fee structure.
WCI- now that we have heard your least favorite two ways for these nearly 6 million professionals to be paid, can you tell us the two best ways? If you were to advise one of your readers seeking financial counsel that was set on working with a professional, how would you want that professional to earn a living?
The one and only way I would ever pay a financial planner type is either flat fee or hourly. Anyone charging commission of any type or percentage of my assets will never get my business.
What would you consider a “fair” hourly rate if that is what is chosen? Let’s explore something briefly. If the commission on a sale was $15,000 and the account lasted the life of the account owner let’s hypothetically break that down into an hourly wage. I’m going to be fair on this.
The account owner opens the account at 30 years of age & lives to be 75. Let’s say the account owner & finance professional meet 3 times a year for an hour each session. Let’s also say that at least 1 hour of prep work went into each session on behalf of the financial professional. Throughout each year there are probably various things to come up within the account (value requests, loans, beneficiary changes, death claims, etc.) so let’s estimate that the administrative work on the account takes 5 hours per year. Over the life of the account, this totals right short of 500 hours of work on that specific account.
If a financial professional came to you with a $30 hourly rate, would you take he or she seriously? Does $200 an hour sound more credible? I’ll let you all do the math on the scenario where the financial professional charges $200/hr on the account.
Maybe this will shine light on commission paid products. If the financial professional has a very high lapse rate than yes, he is “unfairly” earning on those accounts that have lapsed. However, their are many trusted financial professionals that work with the majority of their clients for the life of the client. Sometimes (like the above scenario) these financial professionals take a pay cut by earning commissions & not charging hourly. Food for thought.
Don’t know and don’t care. My finances are and will remain so simple, that I highly doubt I will ever require the “services” of a financial planner. I’d estimate that most doctors are in the same boat.
Regardless of the pay rate, it would take a lot at this point for me to take any financial planner seriously given my past experience with the putrid dirtbags who have tried to con my family members and me.
As far as the hourly rate of a commissioned salesman, that isn’t so much my issue with commissions. It’s more the conflicts of interest. I don’t even have a problem with someone charging a very high hourly rate. I think Allan Roth is up to $450 an hour for his advice. Fine. People know what they’re paying and what they’re getting and Allan is being paid enough that he can be extremely objective with no need to sell anything. The second they don’t see that much value in the advice they can move on.
What do you do for a living, Will?
Will is a life insurance agent who has made many comments on the blog in the past. Who else did you expect to be defending the commission model? Everyone else sees the problems inherent in that system. There are really only two reasonable arguments a commissioned “advisor” can make for his model.
1) They will not only take you with very limited assets, but may be the cheapest for very small accounts. A 5% load on $2K in mutual funds is only $100.
2) Some people won’t pay for advice at all if you make the transaction hyper transparent.
That’s pretty much it, and I don’t really buy either of them. In the first case, the quality of the advice is low and there is no price too low for bad advice. In the second, people need to pony up, get over their behavioral issues, and pay for a what a service is worth.
It’s awesome that finally the crooks that have been taking advantage of people are finally brought to light. I have this problem with my 401k at work. I constantly bring up why am I paying more for poor funds. They have to have “active” managed funds. I haven’t been able to convince my boss to change mainly because most of the higher ranking official are not hospital employees so there’s less of an interest to change the plan. It’s frustrating.
Very often the company might have a cozy relationship with a record-keeper. They might get discounts on administrative costs which are paid for via revenue sharing (which comes out of your money). In most cases the record-keeper might justify the high fees saying that they are ‘average’ for the industry, and it turns out that they are correct: the smaller plans pay some of the highest fees, so they can justify using high cost funds on that basis alone.
Retirement plans are notorious for charging asset-based fees, and they will never change because asset-based fees are addictive.
http://litovskymanagement.com/2015/05/cost-of-fees/
Since the commissioned model pays so terribly, perhaps all those guys should change to fee only. 🙂 There must be a reason they don’t, and I doubt that reason is because they want to earn less.
Look, I don’t have a problem with people working for commissions. I pay commissions to my business manager on ads she sells. But if a potential advertiser comes to her for advice on what website he should advertise his business (or whether he should do it at all), he would be a fool to think he is getting unbiased advice.
It’s like paying a doctor a percentage of the cost of the lab tests and x-rays he orders and the prescriptions he writes. That’s such a terrible way to pay for advice in medicine that it is illegal!
Now if someone has decided he should buy a product that happens to pay a commission, and he goes to the salesman who tells him all about its features and helps him compare it to other products on which he earns a commission but that person gets unbiased advice elsewhere, then fine. Or if someone goes to 5 different salesmen to learn about each of their products (but has independently decided or been advised to actually buy one), then fine. But going to the commissioned salesman for the advice is a mistake.
Will,
I really don’t understand your argument. 200 dollars an hour with 500 hours put in is still only 100,000 dollars. Over the course of 20-30 years this is actually not that much money when most doctors should reach the 1 million mark in the first 10 years of the practice. That leaves the next 10-20 years where they are at over 1 million dollars. Let’s say they pay ZERO for the first 10 years of advice. On a commission base of 1% over the next 10-20 years they are still paying WAY over the 100 grand you mention as the “high” amount in your argument. And 1% is fairly low when it comes to commissioned advisors. Most charge 2-3%.
I think you are arguing for commissioned pay, but in the argument you make, you actually just proved WCIs point.
Thanks.
Dear Will,
As a highly compensated physician, I am considered a “whale” by those in your industry. Much like WCI, I woke up and took charge of my finances after educating myself. I also have managed to enlighten my physician father and many other colleagues about how easy it is to do it oneself. It’s really, really simple. Frankly, your services are not really required. I get it that you want to make a living and are justifying your fees. If you can attract clients, then more power to you. That being said, and meaning no disrespect, you are basically a salesmen selling overpriced (and in my opinion, unnecessary) self-serving advice. I have attended fancy schools (including a degree in Economics) and I know people in Wall Street and Silicon Valley that work in the financial industry. My two nephews are also Ivy League business types, one who works for a large hedge fund in NYC. These people I know have the bulk of their own personal assets in index funds. That tells me that if smart people who do this for a living don’t walk their own talk, then who am I to pick stocks or mutual funds? Also, they don’t pay AUM or flat fees because DIY is so easy. Sorry to be negative about your chosen profession, but your statements deserve a strong reply. Lastly, I met a financial advisor with a solo “practice” (AUM around $150 million with fee of 1%). He told me that he works maybe 20-30 hours/week basically “hand holding” his clients with phone calls/golf/dinners/etc. I admire his business acumen but lament he is probably clearing $1million/year for not doing much. Not bad for a guy with a BA from a local college. Sometimes EQ trumps IQ.
I saw it this way. I had two options. 1- Use financial advisors. But with their 2/20 AUM model I thought thier fees were to high. Plus they got paid even when I lose money. 2- Buy no load mutual funds. The fees are low, but their returns don’t beat inflation. A S&P500 EFT only pays 4.5% for 10 years, yet inflation is 3%. Therefore, you only are getting 1.5%. I become a DIY and starting using value investing methods and invest in individual stocks. Recall the old saying, “Necessity is the mother of invention.” I get 44% retun for 1 yr and 36% for 3 yr (APY). Granted I have to do my own investment research, but it is worth it. My 2 cents.
2 and 20 for an advisor! That’s a good living if you can get it. I don’t see it very often outside of a syndicated real estate deal or a hedge fund though. It’s awfully easy to find someone willing to manage a 7 figure portfolio for 1%.
Also, not sure why you think an S&P 500 pays a certain percentage or why it would be only 4.5% over 10 years. Your link is to a financial advisory firm, so I assume you’re a financial advisor. Which makes me expect a few things from you, like historical accuracy. So let’s at least lay out the facts correctly.
All numbers nominal (real) and annualized (not average) from here: http://www.moneychimp.com/features/market_cagr.htm
S&P 500 annualized return including dividends for the last 10 years (2007-2016): 6.93% (5.03%)
Stock market annualized return including dividends for the last 90 years (1927-2016): 10.05% (6.90%)
Stock market annualized return including dividends for the last 146 years (1871-2016): 9.07% (6.88%)
Now, do any of those numbers look like 4.5% (1.5%)? Not to me they don’t. Not even close. Sure, I bet you can cherry pick some time period where you get that, but that would be exactly what you get. (Try 1999-2008 or 1965-1974 for particularly bad decades). Hardly a reason to invest in individual stocks and take on uncompensated risk, especially when the majority of the data shows that gives you even lower returns than just buying all the stocks.
So now that you’re sitting on a 36% 3 year return (I assume that’s an annualized number), what you (and your investors) have to ask yourself is are you lucky or good (i.e. will it continue)? And unfortunately, by the time that answer is known, it’ll be too late to do anything about it.
Sure, I’ve done that a number of times. I like a flat annual fee for investment management and an hourly rate for financial planning. Are they perfect? Nope, but in general the conflicts of interest are far lower than what you see with commissions and the price is far lower than what you typically see with AUM fees.
@TC I work in the financial planning world & like to think of myself and the genuine group of professionals that surround me as the exception to most of this plague that is personified here.
Below (and several previous posts about commissioned based salesman) you mention the conflict of interest. I cannot help but agree. 1 Timothy 6:10 is the root of just that.
When working with commissioned based financial professionals it is extremely important to look at their history of retained clients. For potential investors this is a must. If the life of a client relationship is a long one, that should be a great sign that said financial professional is doing what is in the investors best interest…not his or her own interest of commissions.
As a devout Believer & someone who has worked on commission in 2 different industries (one in college & now a career in post-grad) it’s tough for me to stereotype everyone on a commission pay structure as the way you personify them. Though you are correct in that, there is much evil in the world & (often times) the root of it is money. Commission, fee, AUM or hourly based financial professionals cannot work for free & it’s unlikely that everyone will ever agree with either pay structure they earn.
Thanks for the discussion, WC. I always enjoy reading your posts.
I don’t expect anyone to work for free. And I don’t think people giving advice under the commissioned model are evil. But I think it is very hard, even for a good person, to always do the right thing especially when faced with such a terrible conflict of interest.
The alternative hypothesis to your argument about client retention is that the clients just aren’t very knowledgeable about the conflicts of interest, investments in general, and alternative advisory options. Frankly, I think that’s more likely.
Aside from the conflicts of interest, the other issue, particularly in the mutual fund world, is that even looking beyond the load, loaded mutual funds are inferior investments to the best no-loads. So not only does the investor pay for the advice with a load, but he then gets bad advice to invest in the high ER, low return mutual fund. Less of an issue on the insurance side, although I suspect the more inferior the insurance product, the higher the commission that must be paid in order to get it sold.
“But I think it is very hard, even for a good person, to always do the right thing especially when faced with such a terrible conflict of interest.”
cant help but make the correlation to fee-for-service model we have in medicine. government regulators are changing it for precisely this reason: even good intentioned doctors abuse the system.
No doubt medicine has issues as well. But I’m not writing about those here.
I realize WCI doesn’t wan’t this to generate into a health care discussion, but I think your analogy is spot on and a great way of understanding the problem with commissioned financial advice. Economics/ psych experiments again and again demonstrate the power of financial incentives to influence behavior.
We see this all the time in medicine, and even good physicians can truly convince themselves a patient needs an unnecessary procedure or test when RVU incentives are at stake. The scary thing is, doctors are likely self-selected to be less greedy and self-interested than average. Apply those same corrupting incentives to the cohort that went into finance! Enron comes to mind.
Not a single doctor needs an advisor for stock and bond investing
Professionals are needed to set up ret plans, estate planning, accounting, etc but why waste dollars for someone to tell you how to invest in the markets when we know the best way
Passive investing in a diversified portfolio of no load index funds and rebalanced yearly
ARE you as smart as a fifth grader. Then you can learn modern portfolio theory and utilize it
What if the doctor didn’t know passive investing was the way to go? What if they did know it was the smart thing to do, but didn’t know how to actually put it in practice? Or what if they didn’t want to take the time learning MPT?
If they went to an hourly planner and paid for 4-5 hours of time for a recommended portfolio with an asset allocation in line with their risk tolerance and financial goals, along with specific index fund recommendations and instructions on how to set up the account on Vanguard, would you consider that a waste of money and/or time?
Ken,
The overwhelming majority of DIY investors cannot implement any investment method, whether it be simple passive investing, or some type of well thought out active program. In fact, the data is pretty overwhelming against your point. The Dalbar studies on brokerage and 401k behavior clearly point this out.
The Dalbar study has serious flaws in that it did not account for the effect of ongoing contributions. In a rising market, it appears the investor returns are less than the investment returns, and vice versa in a falling market.
Although I do agree with your point that most investors would benefit from getting good advice and service at a fair price. That said, it’s not like it is really all that hard to either learn to do it effectively or to actually do it.
So WCI,
How did you respond to Email #2’s question about the life insurance policy?
I don’t recall, I wrote this months ago. But chances are we discussed many of the principles found in this post:
https://www.whitecoatinvestor.com/how-to-dump-your-whole-life-policy/
I can answer that as I was the person that wrote that email a few months back. WCI’s advice was to exchange that policy for a Vanguard variable annuity, and then sell the annuity. Because losses on annuities are tax deductible, while losses on insurance policies are not, the idea is to try and mitigate some of the pain by having Uncle Sam cover part of the losses. Being in the highest marginal tax bracket, I could conceivably cut that loss by 40%. I haven’t actually initiated the transaction yet, but I did stop making any further premium payments into the policy, allowing instead for my dividends and existing cash value to cover the cost of insurance. That way at least I’m not throwing in good money after bad. Per the agent I spoke with, with no further premium payments, my policy is on schedule to lapse in 2095, a full 80 years from now. I’m waiting for an illustration from them to show exactly what the numbers will do from here on out, and once I get that I can hopefully make my next move.
A comprehensive financial planning engagement might take 20-40 hours depending on how many investment accounts, employee benefits, insurance policies, real estate, tax matters, and client meetings. At $150/hr that would be $3,000-6,000 fee-only charge. Does this seem reasonable to you as a one-time charge or annual retainer?
I also try to limit my fees to 1.5% of their annual income so that I can work with younger people who don’t have as much assets yet would benefit from financial planning at an earlier age to accumulate wealth faster.
I see lots of people charging in the $2-3K range for financial plans and in the $1000-5000 range as an annual retainer. Whether reasonable or not, that’s the going rate. If you have enough clients willing to pay you $6K, then as a businessman, I see little reason for you to charge less. But if there is someone charging $2K and you’re charging $6K, and I see the work as comparable, I’m going to send my brother to the $2K guy.
That’s nice of you to “try” to limit your fees to 1.5% of my annual income. I’m not too good at math, but still seems like a bad deal, especially since I don’t know how hard you will “try” to keep your fees low.
I’m a typical resident and make almost $50k/year. After taxes I have around $44k. If I can be frugal enough and save 20% like WCI recommends I have $8,800 to invest assuming I’ve already built up my emergency fund. So your 1.5% of my annual income, or $750, is actually 8.5% of my savings budget… at best. I’d be better off taking the terrible 5.75% front load commission.
I’d rather pay $750 for good advice than $506 for bad advice. Frankly, $750 a year is a very good price for financial advice, even if your income is relatively low and the amount you can save every year is relatively low.
Although I agree with you that there is no reason the cost of financial advice should be linked to my income. It costs what it costs, no matter what my income is. It shouldn’t cost twice as much if I make $400K as if I make $200K.
Good point! Same theory should be applied to one’s investment portfolio. The fee should be the same irregardless of the account size as long as the portfolios have the same investments.
And just to be clear, my recommendation to save 20% of gross for retirement is for attendings, not residents. I’d like to see residents get any necessary life and disability insurance, start Roth IRAs, get any available match, optimize their student loan management, get a will in place, and stop taking out additional debt. If they can manage that, I consider that a win. If you can do 20% for retirement too, then great, but the real secret to physician financial success is growing slowly into your attending income, not trying to do it all on a resident income.
I appreciate your feedback and responses. I seem to be bucking the system of the financial planner industry who only work with wealthier people who already have significant $assets to manage and can afford to pay larger fees, as I do enjoy working with younger people who only make $50,000 per year and don’t have much to invest yet. I believe I have the knowledge and the prompts that I can deliver much value to clients to help accelerate their wealth at an earlier age. Hopefully my fees more than pay for themselves in saving them money in other areas of their lives while also make their financial lifestyle more efficient. Hopefully I can find a way to make my business prosper while doing the right thing even for people who can’t afford the typical industry average hourly fees.
Peter, the 5.75% front load commission is just investment management fee in addition to the yearly ongoing expenses you will incur. I don’t know if you are receiving tax, budgeting, estate planning, and insurance advice too for that fee. But it does sound like you are on the right track DIY and know better than to pay that front load, I wish more people could be as responsible as you.
Really?? 20 to 40 hours! Who is the client, Bill Gates? Are you handwriting the plan out? If it takes you that much time, so be it. However virtually every adviser these days is using an automated system to produce a plan. Yes, the inputs come from interaction and data collection from the client and it takes time to explain the results…but 20 to 40 hours. So, after you talk with a client do you say something like, “Based upon our conversation and your situation, this will require one full week of my time to put this together.” How do they respond to that?
I have been an adviser for 20 plus years and for most of the people I work with it takes a few hours. Your plans must be amazing!
Yep, this is the dirty little secret of the FP industry. After the initial plan, you are paying a retainer fee of about $1000 an hour for your FP to do an annual check on your beneficiary information.
I have long thought that a “coaching” model would work best for physicians, especially for those docs who would prefer an active role in managing their finances. A retainer fee of $100-200/month seems like it would be reasonable, and either party could cancel the arrangement on 30 days notice.
That said, while the docs in the index case emails have fronted the advisor thousands of dollars, buried in complex compensation arrangements, the behavioral peculiarities of the same individuals would likely render them unwilling to pay a much smaller, albeit transparent amount on an ongoing basis. The financial industry has done nearly as good a job as the medical industry in obfuscating costs and fees from the customer.
That’s a real issue- and that’s part of the reason the commission and AUM models persist and perhaps the strongest argument for either model- better advice that has some conflicts of interest or that is perhaps too expensive if it gets someone who truly needs the advice to get it. But I would say that if someone needs advice, they need to realize that advice is really expensive no matter how you pay for it, so if you need it, pony up and pay it or start learning this stuff on your own (the option I obviously took.)
Not all portfolio growth is a direct result of the investments in the portfolio…what if one has an unexpected windfall (i.e. inheritance or sale of business). This amount is automatically reduced by the AUM fee charged by the advisor.
(assuming a 1% fee for the first $1 million fee schedule)
For example , let’s assume you are paying your advisor 1% of AUM for managing your $500,000 portfolio. If you make a contribution/deposit into your portfolio for $400,000 because of the windfall, you are losing 1% immediately from that $400,000 while being invested in the same investment portfolio. Generally, the only extra work involved is actually placing the trades. Merely placing trades should not cost you $4,000.
Music to my ears from a long-term advertiser I have been sending readers to for years now. Virajith is at FPL Capital, perhaps the cheapest “DFA” advisor out there which charges a flat annual retainer for investment management.
This might be true for some firms, but not all. The 1% fee is a thing of the past and most firms are more than willing to work with new windfalls. Nobody should pay a 1% AUM no more than anybody should pay full sticker price for a new car. Furthermore, many, but not all retainer firms have set their fees at a level whereby 1 million dollar or less portfolios are a wash at best in terms of total fees and often more expensive than an AUM firm, particularly firm’s that charge at .5% or less. You can point to the 1% fee example, but that doesn’t make it so.
How many firms can you name that charge less than 0.5% a year? I can’t think of more than a handful, not counting roboadvisors.
I was in an AUM “Wealth Management” relationship for several years. It started when my private practice group moved our retirement plans to an advisor who offered a deeply discounted rate for the retirement plan (0.35%), with the intent of gaining the other business from the physicians at the more standard rates (starting at 0.9% for the first $1M).
I found that early on, my asset base was relatively low, and the firm did a great job with value added reviews and recommendations. I really felt like I was getting my money’s worth. As time went on and assets increased, there was less value added stuff to do, and the gross fees were mounting. I ended the relationship for personal “Wealth Management” service (at 0.9%) at five years and a couple years later ended the retirement plan management relationship (0.35%).
I had nothing against the firm. It is highly reputed, uses DFA funds and ETFs, the advisors were ethical (although mine was nagging me a bit much for friends and family member referrals as potential clients) and well-educated.
That’s what I advocate people paying AUM advisors to do. Convert the AUM fee to a flat fee every year and when the value is lower than the cost, drop the advisor to DIY or move on to a lower cost advisor. But there is no doubt that some docs are more fee-sensitive than others.
WCI,
Great post! When I guested on your site I drew a mixed reaction. Many commenters criticized me and claimed that I had built a “Straw man” argument against the financial industry and the advice that is commonly received with either of these (which are overwhelmingly the most common) models.
https://www.whitecoatinvestor.com/do-not-be-the-sucker/
After reading this post I would say that the advice we received was pretty common. Since getting interested in investing, blogging and educating others I share your experience that this is not at all uncommon. My “Straw Man” scenario actually looks pretty good compared to your examples (and many that I’ve encountered that were far worse than my own), especially the second e-mail you featured. OUCH!
Keep spreading the word!
Cheers,
Chris
If you do not learn the ropes, are you willing to trust these advisors..As Andrew Tobias says “TRUST NO ONE”
It can be taught in an hour
Jim,
Great blog and a great discussion. I would like to offer some additional thoughts on the retainer/flat vs. AUM fee structures.
1. A fee is a fee is a fee. Clients receive a set of services for a total annual cost. Most firms provide some combination of ongoing asset management and financial planning. If you are comparison shopping and services are equal, than the fee calculation is pretty straightforward. Every fee comparison between a “retainer/flat fee” firm and an “AUM” firm, will have a cross-over point whereby one method is cheaper than the other and than becomes more expensive. This of course depends on the portfolio size, and both the “retainer/flat fee” rate and the “AUM” fee rate. This is just simple math, yet very smart people ignore the existence of a cross-over point. Generally speaking, the “AUM” fee structure will be lower for smaller portfolios and the “retainer/flat fee” will be lower for larger portfolios.
2. There seems to be a focus on the AUM fee of 1%. Most of the “retainer/flat fee” firms use this number to anchor prospective clients. It is a nice bit of marketing. While 1% was generally the default fee for a very long time in the profession, this is not the case today. Many excellent firms are charging well south of 1% and often below .5%. I agree with industry voices such as Meb Faber and Cullen Roche that you probably shouldn’t be paying total fees north of .5%. The obvious takeaway is that the smaller the AUM, the more competitive it is when compared to the “retainer/flat” fee.
3. Most firms holding themselves out as “retainer/flat” fee firms are in fact actually charging fees within a certain range and based on complexity. A true flat fee is defined as receiving a flat fee for a service provided REGARDLESS of COMPLEXITY. A good example of a true flat fee is James Osborne who often posts in these forums and has a nice following in the blogosphere. Each client pays the same regardless of portfolio size and financial planning complexity. Now of course, such an arrangement results in some clients overpaying for services and others underpaying for services.
4. As you have pointed out previously, most AUM fees are negotiable, in fact, most firms have this written in their Form ADV document. Furthermore, depending on your individual situation, a well established firm will often make common sense billing adjustments on certain cash balances, certain holdings, or on feeing cash windfalls as they are put to work. The point being is there are all kinds of leeway to work out fair fee structures. Now lets be clear. If you have a $10,000,000 portfolio and require 40 hours of annual financial planning and somebody is going to do it for you for 3K a year than your choice is obvious. Jim, realize that the “retainer/flat” fee is really an attempt to poach larger clients. The fee war is at the 7 figure portfolio level, not below.
5. Your conflict of interest point regarding “paying off a house” or rolling over a “401K” is a red herring. An RIA and/or one that holds a Certified Financial Planning designation is held to a fiduciary standard. Any recommendation contrary to the clients best interest is a violation of one’s fiduciary duty. Furthermore, you simply just can’t roll over a 401K plan at one’s leisure. There are rules that govern such a transaction. A good adviser should never TELL you what to do. A good adviser provides well thought out options and avenues to choose in order to make informed decisions.
6. “Retainer/Flat” fee firms are often setting retainer fee rates and calculation methods to back-door recoup those fees lost in converting away from the AUM model. Calculating fees on such basis as net-worth and income are such attempts.
7. Regardless of fee structure, a client is usually either overpaying for portfolio management or financial planning or some combination of both.
8. Don’t fool yourself, at the end of the day, you as a client are paying for behavior management. In terms of having your portfolio managed it is direct behavior management. In terms of financial planning, it is indirect behavior management. None of this is rocket science. You can acquire most of the necessary skills by reading about 3 books. Let me be clear, I am not advocating one fee structure over the next, only trying to further the discussion and to offer the suggestion that depending on your situation the choice may not be all that clear cut.
Finally, it is my experience in working with all types of high paid professionals that the majority, in fact the overwhelming majority of you guys and gals will waste more of your income on lifestyle choices, depreciating assets, and non-financial investment ideas posed by supposedly smart people in your social and professional network than if you paid somebody 2% annually to manage your portfolio. Just a thought.
I find people willing to work for 0.5% of AUM to be very few and far between. There are still plenty of 1%ers. In fact, I just turned down a prospective advertiser this week whose fee structure starts at 1.5%.
As far as the crossover point, most AUM folks avoid that issue by simply not taking you until you hit a certain minimum.
And I think you have way too much faith in the fiduciary/RIA/advisor ethics issue. I’d like to think that’s the way it is too, but I just get too many examples sent to me every week indicating otherwise.
My financial advisor has charged 0.5% AUM for the past 25 years. He’s prodded me to finally create a budget, a family trust, and medical powers of attorney. He taught me about asset allocation. He kept behavior in check 2008-2009. He strongly discouraged me from investing in an ethanol plant, which would have come on line late-to-the-party. He’s made recommendations on another of my portfolios that he does not even manage. He runs retirement scenarios to help me see my financial future. His staff does the icky paper work to transfer appreciated assets to my designated family and schools. Being wonderfully transparent , he answered my query on fees.
……………….( *SHOCKED TEXT EMOTICON*)……………………
I can no longer suffer the $22,000 in fees I paid him last year. Good-bye trusty advisor. Hello to Wealthfront .
Imagine if you’d been paying 1%….
This is a great point. The financial industry has an amazing business model for them, but not so much for clients. Paying $22,000 simply b/c your fees remain under management of an advisor who currently is doing nothing for you simply b/c they have done a good job in the past is the same as paying your surgeon for reconstructing your ACL or doing your bypass procedure in 2015 and then paying them an even larger amount in 2016, 2017…and forever forward when they have nothing more to offer you. This sounds absurd in virtually any other industry, but is what happens in these models in the financial industry. I think this is possible b/c advisors make things overly complicated to justify their existence and use these models where it takes work to figure out what you’re actually paying and so out of sight, out of mind.
I had a friend ask me to look at his father’s investment advisor this week. They’re charging wrap fees that start at 3% and scale down to 2.25%. Insane!
This is less insane, just slightly deranged. I heard from a non profit foundation this week paying 1.75% on their assets for a portfolio under $500K. They have a total of 16 holdings and it trades monthly. Total costs in excess of 2.25%. They are now (finally) dissatisfied because they cannot get answers to some of their questions about the whole set-up.
They have agreed that they basically want a buy and hold mix of Vanguard Admiral funds that will cost them 8.6 bps. Their adviser now will provide them an IPS they can actually read instead of the convoluted jargon of their prior IPS and a simplified asset allocation model that will require minimal ongoing management. They are no longer going to pay AUM charges. They are very relieved to find this option.
All of my friends use financial advisors. This is the fact that I’ve actively tried to talk them out of it many times. Heck, I’ve been offered to help them. They have no interest in learning how to DIY and think that it’s too complicated and that financial professionals can do it better. I assume they think I’m arrogant and that I really don’t know what I’m doing with my DIY approach. I just don’t understand how someone can go through 8 years of higher education and still not want to do the small amount of learning required to manage ones own finances. My favorite line after someone meets with their advisor- ” how many whole life policies did you buy?”
Jim’s article hits the major points. As many as 99%+ of all advisers charge asset-based fees, and this won’t change any time soon. I started out charging a 1% fee because that’s what the ‘best’ advisers did. However, let me emphasize one important fact. A true fiduciary will never charge asset-based fees for the following reasons:
http://litovskymanagement.com/2012/08/no-aum-fees/
The conflict of interest is probably the biggest concern for prospective clients. It comes in many forms, some of them happen on a subconscious level. It is a red herring that a so-called fiduciary standard is going to prevent your adviser from working against your best interest. There are plenty of CFPs and CFAs who sell products and who wear a salesperson’s/broker’s hat, and it is a fact that they do not have to adhere to the fiduciary standard when they sell stuff to you. Even if a CFP is not selling products, there is nothing stopping them from charging you a 2% fee, even though it not in your best interest to pay this fee, and you better believe it that they will do everything in their power to get more assets under management from you, one way or another, if they are charging an asset-based fee. AUM is all these advisers talk about – how much assets under management they have, and this is all that is written about in many articles in the magazines they read. How to get more AUM.
Many AUM advisers will also place you in a high risk portfolio to justify their fees, and I think that’s probably one of the biggest issues. Of course, debt repayment is not going to be on their agenda – that’s why many contend that debt is good, because this will maximize their AUM.
This effect can be seen with retirement plans, where fees for small practice plans are simply astronomical. Any random plan I take will have an expense ratio that starts at 1% and goes up to 2.5% (or even higher). It goes without saying that if you have a practice, you should not be paying any asset-based fees for your plan, and it is very much possible to get a plan that has low cost index funds and absolutely no asset-based fees.
Jim, I was disappointed at your criticism of the aum fee model. You’ve featured an article on me in the past-I practiced pulmonary /critical care medicine for twenty years before transitioning to fee only financial planning . My clients pay aum-generally starting at 0.75% (rarely more), and dropping to 0.25% annually for amounts over 2M. They get comprehensive financial planning with unlimited access to me for that with no additional fees. I use the lowest cost investment vehicles suited to the clients’ goals-averaging 0.3% a year. Most of my clients get my expertise and investment management all in for about 1% a year. If they have more than a couple of million dollars, then they are paying about 1/2% aum per year. I have seen some getting hourly planning and it doesn’t compare to full time access. Hourly planners see their clients once or twice a year and “miss” a ton of issues. Below find an article I wrote this week for a journal on the price of not paying a planner.What Does It Cost Not to Manage Your Financial Life?
Steven Podnos MD CFP®
We hear the opposite question all the time-how much do you charge to manage our money? So, I’ll ask how much it costs if you don’t have it managed.
It is not just the actual asset allocation and the monitoring of the portfolio. It is the lack of a cohesive approach in organizing all of your financial and life affairs. The costs of not doing so can and usually is extraordinary.
Starting with the money itself, we see countless examples of “portfolios” either stuffed with hyper expensive products enriching brokers, draining several percentage points a year. If you use a brokerage house, do you even know all the costs and how well they are hidden? Even among “do it yourselfers” we see recurring mistakes with emotional behaviors such as chasing the hot stocks and selling in temporary lows. It is rare to find the non financial individual who has the discipline to stay diversified and invested through thick and thin.
It is the cost of not having proper asset protection in place-many sleepless nights can ensue and a potentially terrible financial cost can result. It is the cost of paying too much in taxes year after year. It is the cost of having the wrong retirement plan, paying out high fees and unnecessarily high employee costs. It can be the cost of not noticing that a restructure of debt could save thousands of dollars a year. It is the financial burden of buying too expensive a car or a home at the wrong stage in life.
It is the cost of not having enough disability insurance when an illness or accident occurs. It is the cost to your family if you die with inadequate life insurance. It is the cost to your heirs if you did not organize your estate planning properly.
Not preparing for future college expenses comes home to roost at the same time you might be getting serious about preparing for retirement. What will you use the money for-the kids or your own financial security?
Not being realistic about how much you can spend safely in retirement is a common issue-and can be a jarring reality faced late in life.
I could go on, but you get the picture. The small cost of having a trusted advisor pales when compared to the costs of not having one.
I
I agree, to an extent, of your criticism of the criticism of the AUM model, in that if you pay a fair price and get good value (for anything, including financial advice) that you are doing well for yourself. But why does it have to be AUM? Why not charge your clients $1000/month or $2500/quarter or some other fee for the same service? It would remove the perception of possible conflict of interest, and if you set your fee at the right number, you will make roughly the same amount in fees.
Again, my experience was described above, but I found that as my assets (and fees) were increasing, the new ideas and help were decreasing. I decided that rather than pay $15,000 or so per year in fees, I was better off saving and investing the $15,000.
So you’re saying if instead of charging 0.75-0.25% per year on $1-2M, you charged a flat, annual, upfront fee of $5-10K your advice would be worse and your clients would do worse? That doesn’t make any sense to me.
If someone needs an advisor, and they find someone who offers good advice at a fair price, I don’t really care if they do so via a flat annual fee, an hourly rate, or an AUM fee. But of those three methods, I think it is far more likely that they will pay too much under an AUM model. Take my friend who emailed me today to look up his dad’s advisor. Wrap fees of 2.25-3% a year. If he had been asked to cough up $30K once a year, he probably would have looked into what the going rate really is in the profession. But since 3% seems like such a low number…
Of course if someone needs advice, and if they’re getting more value than $15K out of the relationship, then sure, $15K a year may be a good deal. But $5K is an even better deal.
Steven,
I too am a financial planner (not an MD though, wife does that) and run a hybrid business model (flat fee for financial planning, AUM for investments, commissions on insurance, fee for taxes and student loan advice) I agree with you and with WCI. WCI made an extremely valid point in another post about how most of someone’s financial issues can be taken care of the first year out of training and put on autopilot for a few years (up to 20 years). This especially holds true to insurance, buying the maximum amount of disability and life insurance means there is no need to review those policies (and charge) for reviewing those policies every year (save for bene changes). I agree with this and this is why I sell disability and life insurance and don’t make it a part of my AUM value to clients.
Business model aside, people need an adviser who provides great advice for their situation. There are many flat fee (investment) advisers who cannot touch my quality of advice on many financial issues (taxes, student loans, insurance, actual financial planning), and they probably charge more! I think WCI takes exception to this when that advice is $10,000 per year, every year, with no new real value being added for that fee. While to us, the 1% fee is transparent, it is out of sight, out of mind so that seems to be a real issue for WCI too as opposed to writing a check whenever an invoice is sent to the client.
I think most “flat-fee” advisers (mostly investments driven) should be labeled as “capped” fee advisers in that they probably used an AUM formula to create their original “flat-fee”. Their flat fee may be 5% for someone with $100,000, 1% for $500,000, or .5% for 1,000,000.
My daughters 401 THROUGH A Big hospital has target ret plans 5 times the cost of vanguards
Obviously someone in the hospital gets a kickback
Have come to the conclusion that most Americans truly lack the knowledge to invest properly even though it’s easily learned. As such a fee based advisor would be quite appropriate. Those here if they proceed with an advisor would be very wise to get a second opinion on the investments the advisor recommends. Posting it here would get you many second and third opinions to reassure the investor he was placed on the right path
Did you mean fee-only? That’s not the same thing as fee based.
A fixed fee
Nothing based on asset size
My financial adviser’s firm didn’t charge me anything during residency. Right out of residency I had a mixed fee structure. There was a yearly fee of $1500 (waived for residents). I also paid an AUM fee that started at roughly 1.7%, but would eventually go down to roughly 0.75%. With the free service during residency and not having much invested during the first 1.5 years until I stopped using them, I really didn’t pay too high of fees for the 2 years I had this company.
What I got for those fees was someone who found the best offers on disability insurance, term life insurance (though they sold me on converting part of this term life insurance to VUL, which wouldn’t count as AUM but would give them commissions), someone to set up my accounts, give me an asset allocation, maintain that asset allocation through all of the accounts, perform the roth conversions for me, find a good doctor loan, give me praise for living a low cost lifestyle and buying a small house, and was available via phone or email at any time to answer my questions.
We had worked out how much I should save each month in order to retire well. It worked out to about 25% of my salary. However, when I first started getting an attending paycheck, instead of investing it right away, he had me take that money and pay off my higher interest rate student loans. Once those were paid off he then me save up several months of that money for emergencies. Finally, he started me investing. (Aside from the 401(k), which I started right away).
He helped me get a solid foundation. Now that I know more, I would have changed a few things. But I think he sincerely believed that everything he was doing for me was for my benefit, even the VUL, which has been reviewed by WCI, and is apparently one of the better, (or less worse) of those products. Using this financial adviser was certainly better than me floundering on my own, spending my money as fast as it came in. But now that I know how to do it myself, they stopped being able to provide much additional value for the fees, hence I do it myself.
Sounds like you got your money’s worth to me.
Some people truly need an advisor to hold their hand and tell them what to do. There is nothing wrong with that. this service is not cheap, but very valuable to those who need it.
Unfortunately it is very hard to find a real fiduciary advisor. The flat fee advisors seem to want to sell permanent life insurance and the AUM advisors want you to not pay off your debt and just invest with them.
I have yet to talk to someone that had genuine fiduciary advice.
I’m sure those financial advisors are out there, but they are as rare as an ER frequent flyer patient who is allergic to dilaudid.
I think you’re mistaking flat fee fee-only advisors for commissioned “advisors.”
I had a buddy recently tell me about their fee only advisor encounter. $2000 for the consultation and she tried pushing them into a whole life policy. She must be getting kick backs for the insurance sold through her firm. Advertised as fee only, with the undisclosed commission in the background.
This stuff really isn’t rocket science, but many are too scared to even try and understand.
Sure it wasn’t “fee-based?”
Many times these ‘financial advisers’ do charge a flat fee, to appear as if they are legit. They even sell ‘financial plans’ sometimes. They may even hold a CFP. But their firm has other ideas, and they often use these ‘plans’ to sell insurance. Making it work for them any way they can.
I guess I am confusing the two terms.
What is the difference between fee only and fee based?
Fee based pays fees and commissions. In the worst case scenario, you’re paying an annual fee and then getting put into loaded mutual funds. In the best case scenario, you’re getting all your advice and investment management for a fee and they also happen to sell disability and life insurance make the commissions when you buy those necessary products.
Often, ‘fee only’ can also mean a flat fee for a financial plan and annual planning, and an asset-based fee on top of that for investment management, AND potentially revenue-sharing paying mutual funds (not necessarily with loads, but definitely with 12b-1 fees).
While I guess anyone can call anything they like fee-only, I wouldn’t consider someone collecting 12b-1 fees as fee-only.
You’re right about “it’s not cheap.” Real financial advice is expensive stuff, even if you get good advice at a fair price.
You are 100% correct. Real fiduciaries are very rare. One thing that real fiduciaries have to work hard on is to make sure that the value of their advice significantly exceeds the fee they charge. This can be done very easily for dentists and physicians, because of their diverse needs. Just opening a solo 401k in a timely fashion for your 10999 job can potentially provide value in tax savings that is several times the fee charged for comprehensive planning. The same goes for a properly structured loan repayment schedule. This by itself can also save you many times the fee. Another strategy that can save significant amount of money would be to use a brokerage window to purchase low cost ETFs inside a 401k plan vs. using 1%+ investment lineup. Ditching VUL and Whole life insurance and buying term is another way to bring value. And I didn’t even get to investment management and fee minimization strategies with small practice retirement plans. So everywhere I look there is an opportunity to get rid of or decrease asset-based fees (and other excessive fees) and to create value. With this mindset it s very easy to justify hiring a fiduciary adviser.
Kon, I fully agree with you. Although I will never pay for a financial advisor as I can get advise for the price of an internet connection and maybe a couple of books. But for those that are too scared to try and learn on their own, there is definite value in this advice. Realistically a good fiduciary advisor at some point should have explained and trained their client enough that they should be able to leave the nest on fly on their own. Then maybe once every several years paying a few hundred bucks for a checkup on how they are doing. You can’t get any more fiduciary than that.
I wish it was that simple. I started out helping out with the family business finances and ended up doing this full time precisely because this can get very complex (especially if you are a small practice owner and need a retirement plan. Reading a book or two on investment management is easy, but try to find out how the stock market works and how you should manage risk over the long term, and you will get 100 different answers. How do you know which ones is right? Truth is out there, but it takes a lot more than a few books to get to it.
I think it may be important to clarify what is a true ‘Fee Only’ advisor.
A true Fee Only Advisor only receives a Fee from the client and ONLY the client.
That fee may be based on AUM, or an hourly rate, or a Flat Annual Fee.
If they ever collect any fee from anybody else (even a 12b-1 trailer) then they are not really a Fee Only advisor.
It is important to ask the advisor if he or she is truly Fee Only and not Fee Based. Many of these Fee Based advisors will also collect commissions from products. Such as insurance products (Annuities, Variable Annuities, Life Insurance etc.) and Mutual Fund Trailers (12b-1).
Another growing area of commissions for some of these guys is in non publicly traded investment funds (such as non publicly traded REITs or other ‘Alternative’ investments. Some of these commissions can be as high as 10%.
Great article as usual. Happily I just got out of an AUM account. Wish i would have done it months ago. I already have preexisting accounts with both Vanguard and Fidelity. I follow a few financial blogs including the WCI and Bogelheads and consider myself reasonably well educated financially. I thought a professional AUM would give me better results. Wrong and I paid a lot to find that out. I am fairly confident in picking funds and my own allocations. That being said I have a large cash position that I need to invest (I converted all my AUM to cash). My question is what do you think of Fidelity’s financial consultants? I would not blindly follow his/her advice but having someone to bounce ideas off would be nice. I’ve had stock funds for years but am new to bond funds, CD’s, laddering etc and think I could use a pros eye in these areas. Example – do I want bank or brokered CDs? Hope you will do a post on these in the future. BTW I am recently retired but not yet taking SS.
Good questions. Fidelity ‘consultants’ are nothing more than AUM salespeople. Don’t expect them to give you any type of fiduciary advice. And they actually charge AUM fees if you want to hire them as ‘advisers’. Because you are retired, you are in the distribution phase, so your investment strategy will be significantly different from the accumulation phase one, with an emphasis on principal protection, income generation and tax efficiency as well as estate planning and asset protection. This is a significantly different problem than selecting an asset allocation while you are making contributions. There are multiple issues to consider such as how to manage risk, how to generate income, tax implications, strategic Roth conversions (if necessary), rollovers, account consolidation, and of course asset allocation and product selection. This is where you might sometimes benefit from SPIAs (on which WCI has written many posts), but of course you don’t want your annuity recommendation to come from a broker, but from a fiduciary adviser. You’ll need a comprehensive investment plan which is not just getting someone to give you a spot check here and there as you can’t make any mistakes now that you don’t have any significant new assets coming in.
Thanks Ken. You’re right I can’t afford to make any mistakes. I appreciate the advice and will be wary of Fidelity’s allocation recommendations. I see a consultation with a SPIA in the future as I am very unsure of how to plan for tax efficiency.
I would recommend going to a flat fee or an hourly financial adviser who is a fiduciary, not an insurance broker or a rep, and have them work with you to determine the best products that you’ll need as part of a comprehensive financial plan. I currently have a client who is in his late 60s, so we are going to be actively looking for SPIA products as well as developing income and tax models to make sure that he can get the right level of income from his money while avoiding taking too much risk. Good quality advice costs money because it comes as part of a comprehensive financial review that takes into account your entire financial situation, which takes time and has to be done by a fiduciary who is not trying to sell you anything.
Nothing wrong with an annual check in with a good hourly advisor for questions like these.
Hard to say much about Fidelity “consultants” other than they have an obvious motivation to increase Fidelity’s assets under management and recommend Fidelity’s products. I think I’d go to Vanguard first.
Your point about not hiring an advisor to boost returns is a valid one. They can be great for designing a plan and helping you stick to it, but their plans aren’t necessarily better than those you can come up with yourself with fairly limited research.
Here’s an article about bank vs brokered CDs: http://www.dailyfinance.com/2013/07/11/broker-bank-cds-certificates-deposit/
Fidelity ‘s representatives in their investor centers are salespeople. They have goals to convert your assets into revenue for Fidelity. They are not analyzing your situation and monitoring it in an ongoing basis. They have your basic rule of thumb portfolios based on your risk tolerance, input your data and spit out an asset allocation. If they put you into their advisory service, (PAS),you pay a fee to be put into about 20 or more mutual funds. Or they now can put you with an independent money manager if you want. Of course there is some kind of fee built in that goes to Fidelity.
Thanks Steve. I will keep in mind that they are salesman and consider their suggested asset allocation while trying to build mostly an index stock and bond allocation. If I receive a hard sell I will consider moving to Vanguard.
The correct way to view this topic IMHO is to ask if the fee is direct (fixed cost) or indirect (variable cost). AUM fees, hourly rates, and commissions are all forms of indirect fees in that an outside variable (portfolio size, time, product sold) dictates the fee. Direct flat fees eliminate those outside variables. For that reason, flat fees take the fiduciary standard to a higher level, maximize objectivity and transparency, and encourage quality and competence by the adviser. If there is a conflict with direct flat fees, it’s that it may encourage the adviser to “make it up in volume” by offering a lower flat fee than the other guy. That is, increase revenue by serving more clients in a way that diminishes the services provided to any single client. That can be resolved by simply taking the opposite pathe – raising the flat fee (assuming one has the experience, credentials, reputation, expertise to do so) to a point high enough to keep the adviser/client ratio in balance and that results in a mutually beneficial relationship (i.e., not free lunch…). In other words, it’s a game of earning fees based on the quality of the advice vs. the quantity of assets. If anything, the direct flat fee encourages the adviser to eliminate waste and be as productive as possible. That’s what we call a virtuous cycle.
This was a pretty poor article. I’ll be the first to admit, not every advisor is great. But there are a lot of good ones out there who are well worth their fee for the vast majority of investors. Let me go into all the ways this thing is deeply flawed:
So, what we have here is documented evidence of investors who don’t even know enough about finance to find the right kind of advisor – one who is an RIA, uses an asset class investing approach and charges reasonable fees (1% or less) and preaches education and discipline. And these people (who are pretty typical, by the way) are going to spend the time necessary understanding the long-term risk/returns in capital markets, how to create and manage a portfolio that is in tune with their long-term goals, and stay the course when times get tough? Give me a break! Ain’t. Gonna. Happen.
But let’s move on to the bogus critiques of AUM fees, because even people who are pretty much full-time (DIY) investors are making these mistakes apparently.
1) AUM causes you to maximize assets under management?
Nonsense. RIA firms employ advisors who are fiduciaries who are tasked with acting in their clients’ best interests. Everyone I know suggests paying down high cost debt and maximizing 401k contributions. It’s almost always better to consolidate outside holdings when possible (except, maybe if you’re in a profession with high liability risks) – and the instances where 401k plans have all the necessary funds to match the portfolio outlined in the IPS is rare. And even if they do, and the client wants to leave the money there, if the advisor is managing the money they can just as easily charge another account for the associated fee. If you’re providing actual value to that pool of wealth, an advisor should be charging for the services that provide that value.
2) Auto pay is bad?
When the client gets their performance reports, the account values and performance is reported NET of fees. So advisors aren’t hiding anything. It’s a matter of personal preference for the client. They sign agreements acknowledging the fees and they see them on their statements. How naive and stupid do you think people are? And you think people who are totally unaware of account charges are fully capable of managing their own wealth?
3) High Minimums?
So you are admitting people need advice, but only people with a lot of money? Many firms offer help to people with relatively small amounts of wealth, anyway, so this is a straw man. And there are now several mutual fund companies and robos who serve this market directly. It’s a free market, and businesses are free to serve the people they want to and think they can add the most value to. If you don’t like it, you can start your own RIA firm charging next to nothing serving people with $50K to invest. Be my guest.
4) Tiered Rates Too Steep?
This is one of the biggest canards I see, even some advisors try to make this case (sadly). Here’s why it’s meaningless: advisors aren’t paid by the hour. They are paid based on the value they provide to the client. If an advisor keeps a client from bailing out of the market in 2008 or going too heavily into stocks in 2007 or too heavily into US large growth in 1999, that advisor has provided a tremendous service to the client that will benefit them greatly over time. Studies on the cost of behavioral mistakes of the average investor (see Morningstar, St. Louis Fed Reserve, John Bogle, etc.) come in at 1% to 2% per year. When you add in the value of a portfolio that is aligned with GOALs and not just a client’s AGE, transitioning them from active to passive investing, and from retail indexing to a asset class approach, using the most highly-structured investment funds, while saving on taxes (using tax-managed funds and asset location) and aiding in wealth transfer (stocks in taxable accounts and bonds in IRAs is a great tool here), it’s easy to see why a good advisor can contribute several percentage points of annual value to a client. Their fee for this service? Why it’s directly related to that value – a single percentage of their wealth.
I’ve never understood why someone would charge the same flat fee for two clients with vastly different amounts. Surely the services above will add significantly more dollars to the average investor with $10M than with $1M, no? Now, the percentage value will be about the same (and therefore the percentage fee the advisor charges should also be about the same). It’s conceivable that advisors cannot create that value, or cannot create any more dollar value on a $10M than $1M client. But those aren’t good advisors.
5) An advisor is able to earn a good living running a business?
So…you want your advisory firm to charge so little they have trouble staying in business? How much benefit is 0.25% fees if they have to fold in early 2008? Or they have to take on 500 clients to be profitable and you never hear from them?
This, incidentally, is one of the issues with flat fees – it incentives “cheeks in seats”: maximizing the number of clients instead of maximizing the quality of the client relationship and value added. If you’re charging $3,000 flat fees for everyone, you have 2 business mandates: get as many people as possible (to the detriment of the quality of advice provided to the clients you have), and do whatever it takes to keep them at the firm. “Allocation for Bears?” Done. 60%+ bond allocations with significant purchasing power risk while avoiding (instead of counseling against) short-term volatility risk. You become a facilitator instead of an advisor. Have you seen the glue traps for mice? People see lower, fixed fees like they see the bait on the mouse trap, without seeing the glue that traps them into a suboptimal advisory relationship. Sure, fees are low, and value received is even lower. Where’s the benefit in that?
These are generalizations, of course, I cannot speak to each individual investor or advisor. But they are extremely experienced generalizations. Hope this helps dispel some of these widespread and oft-repeated advisor misconceptions.
Weird that an advisor who advocates for a relatively high AUM fee would think this is a poor article. Let’s start with YOUR fee schedule (which is probably lower than most AUM advisors above $2M):
So now everyone knows where you’re coming from and why you’re arguing what you’re arguing. For some reason, you seem to think that managing $5M dollars is worth $35K a year. I disagree. I think that’s a ridiculously high fee and I think you’re ripping off your clients with $5M. It simply doesn’t take any more work to manage $5M versus $500K. So if you’re willing to manage $500K for $5K a year, it seems very reasonable to me to manage $5M for $5K a year. That’s the main benefit of an advisor working for a flat-fee. Does it take more clients for an advisor to make the same amount of money when he only makes $5K a piece instead of $35K a piece? Of course. You argue that means that they won’t get the same level of service. I would argue that nobody needs $35K worth of service. Even at a very expensive rate of $500 an hour, we’re talking about 70 hours of work. Assuming 80% of what needs done can be done by a lowly-paid employee, you can probably get 200 hours out of a 50 dollar an hour employee plus another 50 hours out of that $500 an hour advisor.
Now I manage a complex portfolio that has money being added to it all the time (my own) and maybe it takes 5 hours a year. I also manage a simpler portfolio that doesn’t have many transactions a year (my parents) and it takes about an hour a year. Maybe you can explain what you’re doing for your clients that requires another 200 hours of your assistant’s time and 50 hours of your time each year. I have no idea what it is.
Let’s look at the other arguments in your 1052 word comment on a 1700 word article.
Your first argument is that most investors aren’t going to learn how to manage their own investments properly. That may be true, but that’s no reason to charge them $35K a year.
You then argue that reporting after-fee performance is the same as blatantly and clearly ensuring clients know exactly how much they’re paying you. I disagree.
You then provide the same old “value” argument. “It’s not about the hourly rate, look at all the value I’m providing.” Let’s use this one with doctors. Instead of charging you the “usual and customary fee” for your intubation (a couple hundred bucks) I’m going to charge you the true value of it. Well, since you would have died without it, the true value is every dollar you would have made the rest of your life. Let’s say you have 20 years left in your career and you’re making $2M a year as an advisor. So the value of that intubation is $40M. We’ll discount it back to today’s date so we’ll call it $8M. And I’ll give you a 50% discount. So for you, it’s just $4M. That’s a great deal don’t you think? Of course not. It’s a rip off. Just like charging someone $35K a year for asset management.
Last, you argue that if you charged a flat fee you’d need 500 clients and couldn’t service them well in bear markets. Let’s look at that argument for a second. Let’s assume you’re charging a flat fee of $5-10K per year. Let’s assume you’ve got $250K of overhead. $5K * 500 clients = $2.25M. $10K * 500 clients = $9.75M. That’s not enough? Half of that isn’t enough? 1/5th of that isn’t enough? If you don’t feel like you can service 500 clients well, pick your number. Surely you can service 100, no?
I don’t expect you to agree with me. As Descartes said, “It is difficult to get a man to understand something when his salary depends on his not understanding it.” You don’t need to convince me of your value proposition. In fact, you probably only need to convince 50-100 people in the entire world and you will have a great life with a great income. That’s easy enough to do that I can’t blame you for doing it.
Bottom line…there’s a big difference between giving advice and gathering assets. If you are paid to gather/retain assets, you are conflicted when it comes to giving advice. Period. Yes, the fiduciary standard applies, but there’s a ton of gray area as applied to the RIA.
To be blunt, the AUM model is the “hoarder” model. A prerequisite of great advice as related to assets is that it must allow those assets to flow to their highest and best use. AUM pricing is an incentive to keep those assets on a brokerage statement or in a managed portfolio, constraining them for a singular goal (portfolio size as the end all be all of the relationship…). Contrast that with unconstrained capital for portfolio productivity for the client either through portfolio size OR through means beyond the public markets or reach of the advisor such as charitable, entrepreneurial, or many other creative pursuits that can bring tremendous value to the client…
There’s a market for AUM providers – smaller accounts. It’s still conflicted, but at least it’s relatively cost-effective for those smaller accounts. Once those accounts become larger and/or the need for consulting to cover more complex/integrated questions arises, the AUM model is ill-equipped to handle it on many levels.
As for the “cheeks in the seats” analogy, maximizing the number of clients might create a quality of service issue for a one-man shop providing a limited set of services, but certainly not for a multi-service, multi-professional firm with a very deep bench through an open-architecture approach.
Lastly, if your value proposition is your ability to “grow” a portfolio beyond what the DIY client could do on their own, especially if you say that value proposition applies even greater to larger accounts, that’s all well and good, but don’t confuse AUM pricing with an optimal match for the client….AUM pricing keeps some portion of the upside, putting it at a disadvantage when it comes to performance vs. direct flat fees. At the end of the day, AUM pricing is a race to zero percent. Who will be looking to make it up in volume then?
I like your blog .Learned a lot .I am not a doctor or high end earner.I am a retired blue collar worker .There is not many places for the little guy to get started with low fee ,good advice.I was lucky my former company has a top notch 401k with DFA FUNDS ,LOW FEE big funds selection.Most of the firms I interviewed after always wanted me to roll my money over.they usually had a 1% AUM.This always stop me.A number of years ago I found Paul Merriman on line when he owned Merriman.Got a lot of good advice for his firm.He even gives adviced on how he would chose funds like DFA,bond used icy 401k.Thats how it set up now.So far have not seen any reason to move money.Paul sold firm and now is a mentor on line at Paul Merriman.com He even has 3 books on line which are worth reading.There are good advisors out there with free advice including your blog.thanks for your efforts you haved helped our family understand invest,etc better. ( our portfolios have done just fine)
Glad to hear! Merriman does some great work.