By Dr. James M. Dahle, WCI Founder
Once more I find myself needing to chart a moderate course. I run into many do-it-yourself investors who are convinced that the financial advisory industry is hosing everyone. I also run into many financial advisors who are convinced their services are so valuable they should be paid millions. In the last couple of years, advisors have taken to pointing toward two studies, one by Vanguard and one by Morningstar, that seem to argue that the services of an advisor provide an incredible amount of value. Let's talk about each of these points of view and why they are both wrong and right.
The Hard-Core Do-It-Yourselfer
DIY investors are fond of adding up all the asset-based fees associated with advice and extrapolating them out for decades. For example, they might use 1% for the financial advisor fees, another 1% for the mutual fund expense ratios and commissions, and another 0.5% for the account fees (such as a 529 or a 401(k)). In total, 2.5%. So if a portfolio has a long-term pre-fee return of 8% per year, and you're paying all those fees, you're really earning 5.5% per year. The difference between 8% and 5.5% over the long run is absolutely monstrous. Consider a physician who invests $50K a year for 30 years.
At 5.5% per year, =FV(5.5%,30,-50000,0,1) = $3.82 Million
At 8% per year, =FV(8%,30,-50000,0,1) = $6.12 Million
$2.3 Million, or 60% more. Think that's huge? Run the numbers out for another 30 years during the distribution phase and you'll really be in awe. If you can withdraw 4% a year from a portfolio safely, but 2.5% goes to the advisor, the advisor gets 63% of what your portfolio produces and you only get 37%, despite doing all the saving and taking all the investment risk. This is a compelling argument that every investor should be aware of. Fees matter, and they matter a lot. Minimizing investment-related fees are a critical aspect of successful investing.
However, this analysis ignores a couple of important concepts. Before we get into those, let's take a look at another point of view.
The Vanguard Study
Vanguard did a study a few years ago, and their conclusion is routinely trotted out by financial advisors trying to convince you to use their services. The conclusion is that an advisor adds “about 3%” to the returns of a typical client. If you're paying 1%, and getting 3%, well obviously you're coming out ahead.
Where does that 3% figure come from? Vanguards says three places:
- Portfolio construction (0-1.15%/year)
- Behavioral coaching (1.5%+/year)
- Wealth management (0-1.45%/year)
Those are pretty wide ranges. I mean, we're really looking at 1.5%-4.1%, even just taking their numbers at face value. We'll come back to how they break those numbers down later.
The Morningstar Study
These are trustworthy institutions doing these studies. Who doesn't trust Vanguard? Who doesn't trust Morningstar? But it's important to not just take the “headline conclusion” and to actually dive into the data a bit. The Morningstar study discusses three greek letters—the well-known “alpha” (beating the market, as attempted by stock pickers and actively-managed mutual fund managers with negative success on average), the equally well-known “beta” (the market return captured by an index fund), and a new, unknown letter, gamma, which they describe as the value added by an advisor.
Morningstar came up with five “Gamma Factors”, i.e. ways an advisor can add value. They include:
- Asset location and withdrawal sourcing (0.23%/year)
- Total wealth asset allocation (0.45%/year)
- Annuity allocation (0.10%/year)
- Dynamic withdrawal strategy (0.70%/year)
- Liability relative optimization (0.12%/year)
They concluded that the advisor added the equivalent of 1.59%/year of value. Which is great if you're only paying 1%, not so great if you're paying 2%.
Criticizing the DIY Financial Advisor Argument
There are three main criticisms of the DIY argument. The first is that it ignores the effects of poor returns on AUM fees. For example, lots of investors think that having an advisor you pay 1% to reduces your safe withdrawal rate from 4% to 3%, or costs you about 25% of your potential retirement spending. Michael Kitces makes a convincing argument that that isn't the case. The reason why is that if a bad sequence of returns shows up, it reduces not only how much you have to spend, but also how much you pay the advisor. Kitces calculates it out that instead of losing 25% (1% of portfolio) of your potential spending, you really only lose 10% (0.4% of portfolio).
The second criticism is that it ignores taxes. That extra return you get from not hiring an advisor should be reduced by the tax cost of that extra return. If the return is LTCG/qualified dividends in a taxable account and you're in the top tax bracket, it should be reduced by 23.6%. So instead of a 1% extra return for the DIY investor, it's really just 0.76% extra. In addition, advisory fees are often paid out of a tax-deferred account. Although technically only a proportion of the fee equal to the proportion of the portfolio that is in a tax-deferred account vs a tax-free or taxable account should come out of the tax-deferred account. I suspect that doesn't always happen, to the advantage of the client and the advisor. If your marginal tax rate is 40%, it's as if your 1% advisory fee really only cost 0.6%. In essence, you're paying your advisory fees with pre-tax dollars. Now it's a little more complicated than that since you lose that tax-protected and asset-protected space forever, but suffice to say you're not losing the full 1% return.
The third criticism of the DIY argument is simply that it ignores value. As Oscar Wilde said, “a cynic is a man who knows the cost of everything and the value of nothing.” I was cynical before I ever went to medical school, and I would be an extremely unusual person if I wasn't more cynical after 7 years of education and training and 12 years of working in an emergency department. We'll discuss value more below, but suffice to say that a good advisor can add value for many people, even knowledgeable, sophisticated investors.
Criticizing the Vanguard Study
Vanguard says advisors can add 3% of value. But let's break it down.
- Portfolio construction (0-1.15%/year)
- Suitable asset allocation using broadly diversified mutual funds/ETFs (> 0%/year)
- Cost-effective implementation/low expense ratio funds (0.4%/year)
- Asset location (0-0.75%/year)
- Total return vs income investing (>0%/year)
- Behavioral coaching (1.5%+/year)
- Advisor guidance (1.5%/year)
- Wealth management (0-1.45%/year)
- Rebalancing (0.35%/year)
- Spending strategy/withdrawal order (0-1.1%/year)
Now that we've gotten into specifics, things don't seem quite so rosy anymore. First, because their estimates are way too high for some of these things. Consider rebalancing. They claim that provides an additional return of 0.35%/year. I call B.S. In general, rebalancing LOWERS returns. It doesn't increase them. What it does is maintain risk at the preset level. Because stocks usually outperform bonds, each time you sell stocks and buy bonds, you're lowering your future expected return. So I have no idea where they come up with a figure like 0.35%/year. There is no rebalancing bonus when one asset class has a much lower expected return than the other.
Another factor they name is asset location. At Vanguard (like with most advisors), that usually means two things:
- Putting higher expected return assets preferentially into tax-free (Roth) accounts, which is bogus because while it does increase expected returns, it does so at the cost of increased risk when accounts are appropriately adjusted for taxes.
- Putting stock preferentially into taxable accounts and bonds preferentially into tax-protected accounts, which is not always optimal because it focuses on tax efficiency only, instead of both tax efficiency AND expected returns.
Next, the study fails to acknowledge that many of these “valuable services” could be provided with some very limited education. How long does it really take to teach/learn the following:
- Use broadly diversified, low-cost index funds to build your portfolio
- Watch your expense ratios, keep them as low as possible
- Preferentially put high-expected return, tax-inefficient asset classes into tax-protected accounts and vice versa
- Don't focus on income, focus on the total return
- Save 20% of your gross income for retirement and don't sell all your stocks in the depths of a bear market
- Rebalance once every 1-3 years
- Spend taxable assets first in retirement, then use tax-deferred assets up to the top of an appropriate tax bracket, and tax-free assets after that
I mean, I can put that on an index card. I can teach it in a one-hour lecture. I just gave it to you for free in this blog post. A good fee-only, hourly rate advisor can probably convince you of it in just a year or two of quarterly meetings for the cost of a few thousand. But you want me to pay you 1% of my net worth every year for the next 60 years (easily a 7 figure amount and possibly an 8 figure amount) for teaching me that? That doesn't pass the sniff test.
Criticizing the Morningstar Study
The precision of this study cracks me up. I mean, it's great to estimate stuff, but reporting it to 1/100th of a decimal point given how vague the assumptions going into the study are? Give me a break. This is financial planning, not physics. Using those levels of precision misleads those reading the study into thinking this data is better than it is. If you just read through the “study” you realize how much hand-waving is going on. The only reason anybody gives this study any credence is that their conclusions are reasonable. Sure, I can believe an advisor could potentially add 1.59% per year of value. But I would have believed it just as much if the answer had been 1.25% or 2%!
Then the study starts throwing out calculations like these:
Do you know what any of that means? No, of course you don't. Neither do I. Neither do 99% of the financial advisors in the country. But it sure looks impressive, doesn't it? I mean, if they use figures like that, it must be accurate.
Yet when you start looking at the assumptions the study is making to get to those conclusions, you lose what respect you had for their mathematical ability. Check out this chart:
Anything there seem weird to you? These are their assumptions for future market returns. Yes, they assume that the future returns on bonds are 4%, never mind that the 10-year treasury was yielding 2% at the time of publication. How about the assumed returns for emerging markets stocks? Yup, 15.2%, 5.5% higher than their assumption for US stocks. Vanguard's emerging markets index fund, started in 1994, has an annualized return since inception of 7.23%, but sure, if you want to use 15.2%, that's fine. Seems reasonable. I mean, how much can you trust the conclusions of someone who makes such stupid assumptions, even if they can solve a dozen indecipherable mathematical formulas?
Making Sense of This Mess
So where does this leave you, dear reader? What is the value of a financial advisor? Well, like many things in personal finance and investing, it depends. And what does it depend on? It depends on the advisor and it depends on the investor.
The Advisor
It should come as no surprise that some advisors are better than others. Not convinced of that? I encourage you to try an experiment I have undertaken over the last half-decade. I've invited financial advisors to apply to be listed on my recommended financial advisors page. The application is not particularly difficult. Most of the questions are pretty leading, such as “Do you believe you can pick stocks well enough to beat an index fund over the long term?” or “Do you believe you can time the market?” Guess what? I disqualify half the people who apply because they didn't get these sorts of questions right. There are tons of incompetent advisors out there, and I'm not talking about the salesmen masquerading as financial advisors that make up the majority of people who call themselves advisors in this country. I'm talking about “real advisors”, people who are fee-only fiduciaries with designations like the CFP and no red flags on their ADV2. Incompetent. I have no doubt in my mind that a significant portion of these folks are not worth their fees. Add in the thousands of brokers and insurance salesmen masquerading as advisors and I fear the percentage of really good financial advisors could be as low as 10%. But guess what? They all think they're in that 10%. And by the time you know enough to distinguish whether an advisor is in that 10% or not, there's a good chance you know enough to do this yourself if you so desire. There's entirely too much luck involved in a needy investor connecting with a competent advisor.
The Investor
As important as the advisor is to this equation, the investor matters even more. You see, the value of even a good advisor depends a great deal on the investor. Consider a physician who knows nothing about personal finance or investing. An advisor who can get this doc budgeting, saving, maxing out retirement accounts, investing in a reasonable plan, buying appropriate types and amounts of insurance, and staying the course through down markets has likely provided millions of dollars in value over the course of this doc's lifetime. Now consider a physician who is a good saver, understands the nuances of 401(k)s and Roth IRAs, already has a reasonable written investing and insurance plan, and has proven her ability to stay the course by herself in a bear market? How much value is an advisor going to be able to add to this doc's life? Maybe the advisor could tweak the asset allocation a little, but that might end up lowering future performance just as much as increasing it. The advisor could take care of some financial chores. The advisor could perhaps motivate the doc to do some estate planning and toss in a tax-efficiency pearl here and there. But is that going to be worth $10,000, $20,000, or even $30,000 a year? Probably not.
So we see that value is not only relative to the advisor and the investor, but it is also dynamic. Generally, as time goes on and the investor becomes more knowledgeable and disciplined and the plan is put into place, the value goes down. Which is odd, because under the most common payment scheme for fee-only advisors, an asset under management (AUM) fee, the fees generally go UP as time goes on.
Some Recommendations
At the risk of making this post too long to read, I'd like to throw in a few recommendations, none of which should be new to long-term readers.
#1 It Is Okay to Be a DIY Investor
I figure perhaps 20% of physicians and other high-income professionals have enough interest in this topic to develop the discipline and knowledge required to be their own financial planner and investment manager. If you've found your way to this blog and read it regularly, that percentage is likely far higher than 20%. So if you think this stuff is interesting, or if you just can't stand the thought of paying someone else thousands of dollars a year to do it for you, then go for it. You CAN do this. I've done it and so have thousands of other docs just like you. You can reduce that 3% figure Vanguard uses to less than what most advisors charge without too much time or effort. Managing your own finances is likely the best possible return on your time. It will pay a far higher hourly rate than doctoring, at least after you acquire basic financial literacy.
#2 It Is Okay to Hire an Advisor
Nevertheless, if you are not interested in this stuff, if you are worried you won't do a good job, or if you've proven inadequate to the task in the past, you should not feel “money-shamed” for hiring an advisor. There are so many ways to reduce the cost of advice that if you just put a little effort into it, it shouldn't be that hard for you to get the cost below the value provided to you. That value could be millions of dollars.
#3 Get Good Advice
Good advice comes from a fee-only, fiduciary, experienced advisor with an understanding of the academic literature. If the advice generally gels with what you see when you read good financial blogs or books or spend time on good forums, you're probably fine. If in doubt, get a second opinion! It can be done from the comfort of your own home with little effort at no cost to you.
#4 Make Sure You're Paying a Fair Price
A fair price for financial advice is a four-figure amount each year. You're not going to get good comprehensive advice and service for less than $1,000. But you can certainly get it for less than $10,000. Why pay $30K when you could pay $5K? No reason that I can see other than inertia. A bigger problem is that docs don't know what they're paying. If you think you're getting advice for free, you're likely getting bad advice. If you're not sure what you're paying, add it up. The math works like this: Percentage x assets = total fee. If the percentage is 1% and you have $2 Million in assets, the fee is $20K. If the percentage is 0.8% and you have $600K, the fee is $4,800. Now you can compare that to an advisor who charges an annual retainer or an hourly rate, or simply to the value of your own time.
#5 Don't Be Afraid to Negotiate
Doctors are notoriously bad negotiators. Now you don't need to talk about fees every time you see your advisor, but it's probably a good idea to do so every few years, especially if the amount you're paying is a five-figure amount. Most advisors would rather see their fees cut a bit than watch the entire fee walk out the door and down the street, especially if they've already got your basic plan on auto-pilot and enjoy working with you (that relationship thing goes both ways!)
#6 Try to Minimize the Impact of Fees
Start by selecting an advisor who charges less than average. Give serious consideration to paying for your financial planning via an hourly rate and your investment management via an annual retainer. But given how many AUM advisors charge less than 1%, I see little reason to pay 1%, much less MORE than 1%. Then try to pay as much as possible from tax-deferred accounts. Might as well pay with pre-tax dollars if you can. And realize that you're not losing quite as much as many DIYers would have you believe.
#7 Nothing Is Final
If you are like most, the value of advice likely falls as the years go by. There is absolutely nothing wrong with using fewer services as time goes by or even becoming a DIYer. The vast majority of DIYers hanging out on the WCI forum used an advisor at some point. Once a year, add up what you are paying in fees and consider the value of what you are receiving. If you don't feel you are getting good value for the fees, either renegotiate them, change to a less expensive or less comprehensive advisor, or take over yourself.
What do you think? How would you quantify the value of a financial advisor? How can someone tell if they would benefit from hiring an advisor or not? Comment below!
I wrote a post on the personal advisor Vanguard study and came away with similar conclusions.
At the end of the day, the biggest benefit to an advisor is behavioral finance advice. If someone does not have the mental fortitude to stick to the plan in a bear market, the advisor will be worth every penny. Otherwise, a little bit of DIY work goes a long way.
I also literally used a similar line of numbers mentioned above in my post today on who you should be careful talking around about FIRE. My numbers were more conservative, but still make the point. AUM advisors cost a lot of money. Fee only advisors are the way to go, if you should need one.
The amazing thing about this, to me, is that after pointing out to someone how much they are paying their AUM advisor who is putting them into actively managed funds (two friends… Same advisor costing them 1.8% between AUM and ER), they still have a hard time leaving because they feel bad. He is a nice guy.
He must be a really nice guy if you don’t mind breaking up with him for ten million dollars over the next fifty years.
Fee only advising is the way to go if you must pay for financial advice. Appreciate your moderate stance on this even if I am DIY investor.
Really good post this morning. I credit my financial success from encountering a commissioned stock broker soon after I finished residency. Yes I paid some commissions but I avoided whole life. I learned the invaluable lessons of automatic investing (DCA) and the concept of pay yourself first. In those days it was much harder to be a DIYer in that you had to actually mail a check and get someone on the phone. Today with the availability of information and the ease of investing it is easy to DIY. I think using an advisor is fine but just understand how the person is compensated.
I clicked on the “convincing argument” link by Michael Kitces and immediately got wary and had the same concerns that were eloquently stated by the very first commentator on that post. To summarize it I think it is a bit of playing with the numbers to make it look like aum doesn’t have as big an impact as it does. It assumes the portfolio value will hover around 1 million for the majority of time before declining in the end and has to pick one of the worst time frames to retire to get a sequence of returns to validate that assumption.
The vast majority of times using the safe withdrawal rate your ending value of the portfolio is actually much higher than the beginning (often end up with 6-9x initial value). This more likely scenario would actually make AUM fees even more costly per year but is glossed over by the time frame they picked to highlight what they want investors to believe
The most telling thing is that they agree the first year on a million dollar portfolio an AUM fee is $10k and your safe withdrawal rate without an advisor would have been 40k so with it it is only 30k. So in actuality you can think of it as giving the equivalent of 1/3 (not 1/4) of your spendable money to an advisor that year.
Granted taxes and stuff can change the numbers slightly but it is a significant proprortion to pay someone to baby sit your behaviors which as doctors we should be intelligent enough to control with just a few hours of reading a year.
Jim, I liked this article and thought it very fair. Being both a physician and a Fiduciary fee only planner gives me some additional perspective however.
There are three good reasons to consider a Fiduciary advisor (with low fees):
1) That they may recover (or more than recover) their fee by the way they invest your funds compared to what you might do (asset location/ withdrawal locations/a good low cost asset allocation). Here a DIY investor has the best chance-but only if they have the time and emotional discipline to do so.
2) That they may provide value by preventing mistakes of both omission and commission. Whether it is buying from euphoria (tech stocks in the 1990s, bitcoin now, real estate 2005) or selling from fear (2000-2, 2007-10) or just making a terrible mistake in non investing areas (having a big mistake in asset protection is something common I see).
3) That they are worth their fee just for taking care of all the aspects of life in points one and two. There are many things we can do ourselves that we pay others to do. Think of all the insurance we pay for and hope we don’t collect on and how much that costs.
I’d say the percentage of people I’ve come across that can and are willing to do all of this by themselves, and do it well, is more in the single digits.
Very nice post to start the week. I feel you’ve become much less dogmatic in regards to financial advisors over the years – seems to me in the early days you were pretty rigidly in favor of the DIY route! The devil is in the details
Yes, I’ve been pleasantly surprised that there actually were a few “good guys” out there.
That was a fair article. I think a lot of DIY investors do not understand that financial planners do far more than give investment advice, which is where the argument about the cost of advice loses some impact. I also 100% agree with Steven Podnos’ comments. However, I’d like to address an entrenched misunderstanding about “fee-only” advice.
Most fee-only advisors, who are fiduciaries, at least as defined by NAPFA (https://www.napfa.org/financial-planning/what-is-fee-only-advising), are AUM advisors. I believe the AUM model has been so vilified on this site – and others – that most physicians believe that a fee-only advisor does not use an AUM model. That is simply not true. I’m not here to argue whether it is “good” or “not good” for physicians, just that you can hire a fee-only advisor who uses the AUM fee model.
I haven’t looked at the multitude of recommended advisors on this site, but my guess is that the majority use AUM. In fact, we were AUM before changing to a flat fee model after becoming involved with WCI. The industry is slowly awakening to the call for more flat fee planners, but it will take awhile before it becomes common – if ever – because planners are more comfortable the ease of the AUM model.
I’ve noticed that recently too. While it’s no secret that AUM fees aren’t my favorite way to pay for investment management, I’ve never argued they weren’t “fee-only.”
Johanna, the reason the AUM fee endures is not because it is comfortable, but because only %AUM fees can support the many incompetent advisors. Per WCI: “I fear the percentage of really good financial advisors could be as low as 10%”.
WCI, you are well aware of all of the arguments against %AUM fees. Do you believe such fees are logical and justifiable under any circumstances? Why don’t you simply come out and condemn such fees?
Paying a yearly fee at a reasonable number will work for the lazy investor
Investors who pay an aum fee are paying one hefty fee fir portfolios that are basically stagnant
Saw a portfolio with aum fee with significant muni bonds and 12% in cash
Do it yourself. It’s fifth grade material
Really Ken?
I know some smart 10 year olds, but I’m not about to let them run my personal finances.
Just about anyone can manage their own finances, build their own financial plan, execute it, monitor it, and adjust as needed over time. But, few people do. Yes, a lot do – many who follow the WCI content. As a percentage of the adult population though, it’s a small group that is successful with this. Most don’t handle their finances well. For that (rather large) group of people, engaging with a low-fee fee-only financial planner can be a smart move.
A good balanced review. I think the big problem with the wealth management industry is the AUM fee model itself. It makes no sense for the investor and just results in a massive transfer of wealth from those who own it to those who manage it. It’s comparable to going to your doctor and being told he/she will look after your health care for a percentage of your financial assets every year. Good financial advice can be very valuable, but ought to paid for by a flat annual fee based on an hourly rate for work done, including the portfolio management piece. It’s good to see this model being more available in the US, but this model is simply not available at all in Canada, yet.
Try https://bit.ly/2KHrc2t and https://bit.ly/2x1RGcS – some of these firms charge hourly and fixed fees. Good luck!
Thanks, but these firms provide only financial planning advice, (I use one periodically), but not portfolio management. They’ll make suggestions about a client’s portfolio but will not manage the money. We cannot get portfolio management outside the AUM fee model.
Ah, that is very surprising to me. Is there a statute against it in Canada or have investment advisory firms all agreed to use AUM?
I’m not sure of the details, but it’s to do with licensing. There are complex rules around being allowed to manage other people’s money, although it’s ok for bank employees with no more than than sales training to push high fee mutual funds (MERs 2.5% and above), on to their customers. There is a separate licence for discretionary portfolio management, and I don’t know what is required to get one. The result is that all portfolio management is done with AUM, with financial planning thrown in “for free” and others doing just financial planning. Very unsatisfactory. A business opportunity there for someone, maybe?
Does an advisor acting as a fiduciary receive any compensation from loaded and hi fee mutual funds?
Lots of hidden fees in 401k plans which most participants do not realize
Paying a fixed fee as you pay your cpa would be appropriate for many as a start
The problem is that the uneducated investor cannot decipher if his advisor is COMPETENT
WCI, I just wanted to use this opportunity to thank you for making me a DIY Investor. I read your book about 5 years ago as I was set to graduate from residency. I had always been a saver, but had no clue about investing and the majority of personal finance. Fast forward 5 years later and I am almost halfway to financial independence and paid off 300k student loans in less than 3 years. Thanks for giving me a great foundation, as personal finance has become a really fun and rewarding hobby.
Wow, nice comment that will warm Jim’s heart. That was exactly me 34 years ago, except for one crucial difference – there was no WCI. So I stumbled on, making just about every mistake in the book. It took too long, but with the help of a friend, I eventually figured it out, and with a high income and high savings rate am now FI, but should have been so much earlier. So now I enjoy working part time and helping the Residents do it right and avoid the financial pitfalls out there.
Congratulations on your success! Amazing what a high income, a little discipline, and a few pearls of wisdom can do eh?
Excellent article, as usual. I see the value of an advisor is to get many (most?) doctors over the fear about investing. Unfortunately, some will get fleeced along the way. Now that I’ve learned to become a DIYer (thanks to sites like WCI and Bogleheads) I am still surprised that doctors who spent weeks studying for the Boards feel that they do not have the time or background to learn how to invest. After all, none of us knew anything about neuro-anatomy or renal physiology before medical school but all managed to learn it and pass the Boards.
Excellent post. I truly enjoy reading your posts because you are candid……your tell it like it is……no sugar coating.
Great job…………thanks for making these valuable contributions!
Thanks for a balanced and well presented post. A few comments:
You state, “If you are like most, the value of advice likely falls as the years go by”. I would contend that the need for and the value of advice looks more like a smile vs. a declining slope. Early in a career our knowledge level is lower, overconfidence or excessive caution is rife and mistakes can compound over a very long time horizon, which implies increased value potential during this time. This would be true in any career, our day-to-day lives and our finances. Later in life, while approaching and entering retirement, most of us experience some cognitive decline, which implies lowered ability to make effective financial decisions and recognize when we need help. This occurs at the same time we must deal with arguably the most difficult ongoing and complex analysis, managing the portfolio withdrawal phase, social Security, pension and Medicare claiming issues. I personally feel that having a trusted advisor (not necessarily a paid advisor) later in life is crucial for all.
Today’s Kitces Nerd’s I View post is all about pricing fee for service financial planning, which might be an interesting article for your readers: https://www.kitces.com/blog/pricing-cost-fee-for-service-financial-planning/
Another source for advisors who are fiduciaries and charge by the hour is the Garrett Planning Network: https://www.garrettplanningnetwork.com/ (note I have no affiliation with this organization, nor am I in the financial industry)
Lastly, another information source for DIY investors is the American Association of Individual Investors (AAII): http://www.aaii.com/. Like any information source, I take everything with a grain of salt, but I find they have some useful information.
Thanks for an extremely informative blog!
I like the smile analogy. That check in around the time of retirement could be an important one.
I am a fee-only semi retired advisor – I teach the public (Adult Ed /Councils on Aging etc) 2 hour classes on this very topic (Do It Yourself or find an advisor -if DIY what are best resources… one is Whitecoat) –
Jim is very trustworthy this was well done and I will be able to add to my class stealing some content.
major issue not discussed however is :
in class we discuss the largest most pervasive conflict of interest in our industry -the career risk associated with deviating from conventional/ every day the only market in the news paper S&P 500 -you know “better to fail conventionally….
I am a math guy – short term forecasts are worthless but long term math will prevail – reversion to the mean is inevitable – the S&P has never been more overvalued relative to international stocks as it is now – the prudent thing to do (look at Betterment etc ) is to the extent you are in equities have more in international/EM and be patient!
basing your allocation on world market capitalization is skating tp where the puck was
so I don’t know if an advisors will navigate this for you or not
1 suggestion is to find a top flight fee-only advisor – their value will exceed their cost in the first year and then if they are no longer a good investment leave or renegotiate the fee
if you have a complicated tax situation -they can add a lot of value -if you need that steady hand at the tiller (2008 rolls around again…) might be worth it
good luck!
Great article! A DIY route is gratifying but so is paying a flat fee to demonstrate knowledge gaps. As with mountaineering; no matter how much I think I know, there is value in reading and meeting new people. Thank you for posting about good advisors. As my wife says about finding a mate, “sometimes you gotta get out there and kick a few tires.”
I suspect that the value of adviser behavioral advice, while potentially significant, is being overstated. While advisers can potentially give good advice about investment strategy and behavior ( e.g. don’t sell when the market drops, keep buying when it’s up, avoid fads, ) I’m very skeptical that the typical client actually listens to that advice.
Isn’t there an old joke saying that the reason economists use decimal points in their forecasts is to prove that they really do have a sense of humor? Maybe it’s the same for financial advisors.
I’m not a fan of the AUM fee, but having looked closely at the fee structures of recommended advisors, I’ve realized that many of the flat-fee advisors’ costs resemble AUM fees until you reach a net worth somewhere north of $1 Million.
An AUM fee of 1% might be a bargain when your assets under management are under $500,000 and you’re getting comprehensive financial planning for under $5,000.
When you have a multimillion dollar portfolio, the 1% AUM fee now measures in the tens of thousands per year, and that’s when you want to look to a flat fee advisor or become confident with DIY investing.
Cheers!
-PoF
Do you agree that coincidentally appropriate fees for low AUM clients would not serve as the justification for the %AUM fee method?
I’ll ask you the same questions I posed earlier:
Do you believe %AUM fees are logical and justifiable under any circumstances?
Why don’t you simply come out and condemn such fees?
Well, given the fact that quality flat fee advisors often charge $5,000 to $10,000 per year for clients with under $500,000 or $1,000,000, the math often favors paying the AUM fee, so I wouldn’t categorically condemn the lower-cost option.
Just because it’s not called an AUM fee doesn’t mean it can’t match or exceed an AUM fee.
I’m building a short list of recommended financial advisors, and none will have anything remotely close to a 1% AUM fee or the equivalent once you get into a multimillion dollar net worth range.
Best,
-PoF
I agree that it’s okay to charge an AUM fee. It’s not okay for the client not to do the math once a year and realize what that fee is and compare it to the value received.
I also think that AUM don’t drop nearly as fast as they should after $1M. I see them drop from 1% to 0.9%. That’s too much. But I don’t mind a 1% fee on the first half million with a $5K minimum, 0.5% on the next $500K, and 0.25% after that. I think that’s a very reasonable way to do AUM fees. Personally, I can’t imagine a scenario where I paid more than $10K a year for advisory fees, but the truth is I’m unlikely to pay $1K a year.
Great post Jim! Nice to have you unpack an article or two like this in detail.
I’d think there’d be room for a discount advisor to offer AUM fee for the first million of assets and switch to fee only after that. Unless there are rules/regulations against doing both, it would be a way to be more competitive and offer an up front discount to your clients.
There will always be some people who don’t want to DIY. Not everyone is going to be comfortable with this stuff.
Read the “BIBLES” on investing 43yrs ago and was a DIY investor and along the line made some mistakes but in the long run indexing paid big d ivi,dends
ALL advisors have a conflict of interest-THEY WANT TO MAKE AS MUCH DOUGH AS POSSIBLE
The AUM guys want to have all your dough in their control even if you find other investments you would like to get into
As Andrew Tobias says “TRUST NO ONE”
Wall St is CROOKED obviously
Morning star paper looks great – will review when I get a chance.
A few points skimming the paper and WCI “arguments”
1. You are confusing precision and accuracy. You have to be precise since this is mathematical modelling. 1.59% Gamma is the output. If this is cracking you up, I’d like to know what you think about the g on this earth which is 9.81 m/s^2 (roughly). I suppose we can assume its 10 now …lets see if the next SpaceX rocket can take off earth successfully with that.
2. They are quoting Ibboston market assumptions – for those reading, thats the same company from which Trinity study drew numbers from. I guess they are “stupid” (you know the PhDs and people doing this all day).
3. Base assumptions of returns are irrelevant here. They compared it relative to naive base case of allocation. You can input your lower bond returns, it won’t change the effect much. Difference was all the 5 things that supposedly advisor can do showing a fairly impressive 22 something % income increase in retirement.
*** Again for those reading the largest benefit of ~$10 came from dynamic withdrawl strategy vs simple withdrawl strategy majority of DIY do. Worth looking into.
All of this being said:
1. I do not think majority of advisors are this smart of have tools that do this – atleast the ones that showed up in our residency couldn’t answer when I started asking specifics of monte carlo simulations etc. If they aren’t doing all of these strategies then their Gamma is essentially close to ZERO which means the fee drag is real.
2. I am DIY for reasons beyond this paper and more related my thoughts on capital markets investing.
I’ve lived in the medical world for almost forty years, and the financial planning world for 15 years. There are good guys and bad guys in both worlds. As physicians, many of us do some DIY work on medical issues for ourselves, our families and our friends. But hopefully we know our limits. Some physicians have the time and interest to do a good DIY job in finance, but I’d venture they are rare.
The key is to find a “good” guy in financial advice. If you pick a Fiduciary Fee Only (not “fee based”) advisor, you have overcome most of the obstacles in doing so. As to how the advisor is paid-this is completely up to the advisor. There are no rules on this, no licensing issues. Except, if you hold yourself out to be fee only, then you may not derive any compensation of any type except directly from the client.
If you look at NAPFA or XY Planning (younger advisors), they are fee only. They charge in a variety of ways-hourly, projects, based on net worth, based on complexity, and commonly AUM. I use mostly AUM as I find it most acceptable to my clients-they are used to paying a percentage fee for investments-these fees are already in mutual funds and ETFs. There are two downsides to using AUM for an advisor-first, I often am advising on non liquid investments (business planning, real estate, etc.), and am not being paid for that advice. Second, my income goes both up and down with market prices (thankfully mostly up). I never worked harder than in 2008-9, and took a 30% hit in income at the same time.
It is routinely said that indexing beats 90% or more of the so called professionals; pro advisor is some oxymoron
There is very little an advisor can do to help me fir 50 grand yearly
Wci will give me all the info I will ever need in this arena
Obviously vanguard would encourage using advisors and keeping all the investors m9ney in their funds; conflict of interest