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!
Of course vanguard would encourage using an advisor, theirs hopefully
Once again, a nice post that contains a lot of nuanced information about an important topic. I do have a follow-up question with respect to this post. For those individuals who do not feel comfortable with a self-directed approach, my question is: why not? I am not an expert by any stretch. I began with the WCI book, and from there, read Bogleheads guide to investing, Investor Manifesto (Bill Bernstein), A Random walk, and one or two other classic texts. My take-away: invest in passive (not managed), indexed, diversified funds. Isn’t just as simple as that? Don’t you simply need to buy 3 funds (VTSAX, VTBLX, and VTIAX) and that will suffice? Simply adjust allocation with age to account for risk tolerance, and that simple portfolio will provide the best returns in the long run. I just don’t see how physicians (who are very capable) can’t come up with a self-directed portfolio and simply allow it to grow until retirement.
64 million dollar ?-every educated American can do the same-JUST READ THE BOOKS THE LAST POSTER SUGGESTED
Billions of dollars wasted on useless and greedy advice
I’ve always been a DIY. I certainly wouldn’t pay a 1% fee at this point. It would be over 40K a year. Crazy. That is thousands of dollars per hour … and for what?
On the other hand, most physicians I know have limited financial knowledge and no interest in learning. They use their gut and guesswork which are not good guides. They would benefit from competent help – if they can find it. That isn’t easy.
Some AUM can be helpful but there are always conflicts even with this “fee-only” arrangement. They really argued with my mother when she (rightfully) wanted to pay off her mortgage and take out an SPIA for more income. Both would reduce their AUM and therefore their fees.
dentists are no better
the uneducated are prey to the wall street crowd-they will eat you up if you allow them
my buddy has 400k in cash in h is acct at .65% UM
I thought this article was about financial advisors, not investment advisors. They are not one and the same, although many investment advisors and insurance salesmen refer to themselves as financial advisors. The problem is that the term “financial advisor” is used by anyone who gives advice in any way about financial decisions. It’s not exactly trademarked.
The clunky “flat fee, fee only financial advisor” differentiates, but it’s not exactly catchy and I doubt it will go mainstream any time soon. Those seeking true FFFOFAs must be responsible for doing at least a minimal amount of study to know what kind of advice they are paying for. Apparently, several of the above commenters (Ken, for instance) aren’t aware of the difference.
And then there are FOFAs who actually spend time on areas besides investments, using AUM as a billing method. Steven Podnos, MD, CFP sounds like one of the “good guys” to me.
As others have pointed out, investment advice/management is not difficult, maybe about 10% of the time spent by FFFOFAs and FOFAs. Of that 10%, though, the behavioral advice is 90% of the value. Portfolio construction and understanding the variety of accounts and when to do what adds ~10% of the value. These are observations based upon our specific practice. I would hazare a guess that it’s not much different for other FFFOFAs.
If investment management is only 10% of the FOFA services, then there does not seem to be reason for concern about distinguishing financial advisors from investment advisors.
I assume that any client will want the broad range of financial advice that includes investment advice. The fact that the FOFA does or does not take control of the assets should not be a major factor that affects fees. Seemingly, %AUM fees are only claimed to be justified for investment management; truly a case of the 10% tail wagging the dog.
That depends (paragraph 1) on whether you are equating a FOFA with a financial advisor.
Strangely enough, clients expect a broad range of financial advice, including investment advice, when they are paying a flat fee. Our experience with the AUM model, otoh, was like pulling teeth to get clients to spend time on financial planning beyond investment management. I think they perceived that they were paying based on investments and that was all they wanted. I take credit for being part of the problem – we didn’t have the system we do now for financial planning and I didn’t explain the benefits as well as I should have. The joy of changing to flat fee was that it forced us to change our focus.
Those of you reading between the lines will cipher the reason that most advisors are not interested in changing from AUM. Planning-based advice (as I’ve learned) is a lot more work than AUM. AUM is easy money and the model won’t change until advisors begin to lose serious business. In this insulated little world of WCI, it may seem obvious that the system will have to change, but it is too well-entrenched in the “real” world. At least, imho.
Investing should be simple and boring, most financial advisors will not beat index funds, and the few ones who do, they probably won’t be able to do it again the next year. I would never use an financial advisor, as most of them are crooked, I challenge any financial advisor to charge a percentage only if they can return above index benchmark, and get penalized if they perform under benchmark.
I guess I understand some of the hostility towards “financial advisors” in that most are expensive salespeople. But some of you are making a big mistake in lumping Fiduciary Planners (fee only, and regardless of whether they are paid hourly, flat fee or AUM) with the bad guys. The value of a good planner goes far beyond an asset allocation. I’d bet that Johanna Fox and I both spend less than ten percent of our planning time with clients discussing “investments.”
As to AUM fees-in every case I’ve ever seen, the fee goes down with an increase in invested funds. Our fee drops to 0.25% a year on amounts over 2M. Many of our older clients are paying us the same that they’d pay Vanguard and they are getting a highly experienced and personalized service. Repeated extrapolation of a 1% fee regardless of assets is incorrect and unfairly critical.
Are you serious that you’ve never seen an advisor who doesn’t decrease the AUM percentage on larger amounts? Really? Not to mention most of the decreases are almost insignificant. I mean, if the first million is 1% and the next is 0.9%, do you really consider that okay? I don’t. Hopefully things are changing, but I’ve looked at a ton of ADV2s in the last 5 years that don’t have a significant decrease.
Not to mention the other tricky AUM thing- like a tax bracket, you only get the lower rate on the next million. So let’s say you’re charging 1% for the first million and 0.8% for the second, and 0.3% for the third. That means $10K + $8K + $3K = $21K, NOT $9K.
AUM advising fees feel like realtor fees to me.
I’m not rabid but I am convinced that the vast majority of advisors regardless of the stripe or certification give poor advice. The comparison to medicine is false. It takes 10 years to grow a good doctor and you have to be capable to begin with. There is no gate for this industry.
On top of that, it really isn’t that difficult.
I think it’s important to distinguish between two things here:
The first is managing your own finances and the second is managing the finances of others.
The first is far easier because you must only learn that portion of personal finance and investing that applies to you. You might have to learn 10 times as much to assist others competently.
For example, I didn’t need to know anything about student loan management for my own finances because I never really had any. But to help others, I had to learn a ton. Same thing with everything else.
Don’t underestimate the difficulty of being a competent advisor of others; it is a much higher barrier than just being able to competently manage your own finances.
%AUM fees are excessive or exorbitant for HNWI. Neither PoF nor WCI suggest that there is any logical basis for charging AUM fees, yet neither seems willing to condemn such fees. They rationalize such fees by noting: that they are often not out of line in the context of low NW clients; that fixed fees are sometimes also excessive or exorbitant; or that some AUM fees are more reasonable than others. They follow the tired FA industry line that any fee is ok if it is less than the value received. Time for a change to a reasonable fee structure like that charged by CPAs, lawyers, and doctors. How about it?
The above is your opinion. Why are you so insistent on condemning all with such a broad brush? It may surprise you to learn that many clients paying AUM are quite happy with the situation and, believe it or not, they are not all ignorant morons.
I believe I am qualified to ask this because I’ve worked on both sides and have quite a bit of history and experience. It appears to me that you have a stick in your craw that is dogmatic and personal.
What is so magical about the way CPAs and lawyers bill, anyway? Doctors have little control over their billing, so not sure why you lumped them in, of all professions.
What’s not to like about %AUM fees? They are, after all, the industry standard fees that are charged by nearly all of the most reputable FA firms. They avoid the constant headache of complaining about nickel-diming hourly fees. They are virtually invisible when deducted quarterly.
Johanna, will you please explain the logical basis used to justify %AUM fees? Now do the same for CPAs, Lawyers, and doctors fees (forget health insurance issues).
I don’t have to explain the logical basis to justify AUM fees – those who charge can justify it for themselves. But your emotional reaction and demands are a turn-off.
I have a much greater problem with poor advice and inept advisors. Too many physicians believe they pay a “fair” fee to their CPAs and get nothing but poor service and worse advice costing them thousands of dollars, frustration, and wasted time. Charging an hourly rate or a fixed fee doesn’t correct the problem.
I believe it’s much better for a physician to pay an AUM fee and get excellent ongoing advice than assume they are getting the same for a flat fee from an advisor with lack of experience and knowledge about working with physicians.
You can find both kinds of advisors if you care to look. Not trying to justify AUM and, as you know, I charge flat fees. But I think you are being willfully blind to other issues that I believe are a bigger problem than the narrow issue that you appear to be so hung up on.
If the AUM fee is equal to a flat fee, why do you have a problem with it? That’s not logical. Fee structure matters, but when it comes to fee-only, I care far less about the structure than the amount of the fee (and of course the quality of the advice.) It’s pretty simple math to compare an AUM fee to a flat fee. I think most of my readers can handle it.
As you pointed out above, %AUM fees for HNWI are excessive and often exorbitant (often far in excess of your 10k limit). Any reasonable fixed fee would be substantially less — think fixed fee based upon estimated hours at a reasonable (even high) billing rate. As you have pointed out many times before, it is difficult to compete on fees with the industry standard %AUM fees, particularly when all the advice is that such fees are “reasonable”.
Johanna, of course incompetent advice is worse than high fees.
You say “any reasonable fixed fee would be substantially less”. I think that any reasonable AUM fee would be substantially less. My point is they’re interchangeable as long as you do the math each year. If it’s 1% forever, at a certain point, the cost will probably exceed the value and you’ll renegotiate, go somewhere else, or DIY. But the market price for financial advice is dictated by the market, not what you wish the price was.
“I mean, if the first million is 1% and the next is 0.9%, do you really consider that okay? I don’t. Hopefully things are changing, but I’ve looked at a ton of ADV2s in the last 5 years that don’t have a significant decrease.”
I believe that your point is that the vast majority of AUM fees are not “substantially less” and not reasonable. Not exactly pristine conditions exist for setting a true market price.
The AUM to flat fee shift is slowly changing. You can either applaud the progress or you can protest that it isn’t progressing fast enough.
I don’t think you can argue that a market price can’t be determined here though. That’s silly. Want market price problems, look at health care. At least you can find out what the price is for financial advice, do the math if necessary, and decide if you want to buy it. A bigger problem is doctors assume that whatever price they’re offered is the market price, which is not the case. More like buying a used car than buying produce. But you can make your own “blue book” by reading a handful of ADV2s or at least some of my posts that tell you what the market price is.
Or, if you have a trusted advisor who has no apparent financial interest in promoting one fee over another, and that advisor says %AUM fees are reasonable, why bother burying yourself in the math?
Uhh….so you know what you’re paying? And multiplying a % by your assets hardly requires you to “bury yourself” in math. You can get a pretty good estimate in your head, or at least on a napkin. This is not a difficult task I’m asking people to do.
there is an inherent conflict of interest with an aum advisor no matter the number
There are also conflicts of interest with flat and hourly fees.
Flat fee: Incentive to do less work on portfolio than is needed or meet less or whatever
Hourly fee: Incentive to do more work on portfolio than is needed or work slower or meet more or whatever
AUM fee: Incentive to advise against paying off debt, leaving money in a 401(k) not counted in those assets, buy stuff, spend more etc.
You can pick which one you want to deal with. It’s up to you. Personally, I don’t pay any of them.
what % of professionals are DIY investors if you know or estimate
Just read random walk down wall street and you will be on your way to DIY Investing-Lights went off after reading it 45 yrs ago
I am a 58 y/o physician who is a finance and investing junkie. I began using Vanguard advisors because both of my parents developed dementia at a relatively early age and my wife has no interest in portfolio management. My rationale is if I develop dementia while managing our portfolio, the cost of an advisor would be well worth it if they prevent me from making a huge mistake.
In one of the rare cases, I have to disagree with Jim Dahle on this one:
“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.”
Using an example of a 50-50 portfolio over say three decades where without rebalancing, the portfolio ends up 70% stocks and 30% bonds, I would benchmark the portfolio against a rebalanced portfolio of roughly 60% stocks / 40% bonds or the calculated average risk during this period. I could not defend how Vanguard came up with the 35bps though but argue it does increase return.
http://www.etf.com/sections/index-investor-corner/boosting-returns-rebalancing?nopaging=1
There is some evidence, however, that advisors time markets poorly:
https://www.cbsnews.com/news/financial-advisors-show-poor-market-timing/
I’m not clear why you’re benchmarking a 50/50 portfolio against a 60/40 one. My point was that a portfolio with an increasing stock:bond percentage has a higher expected return than one with a constant stock:bond percentage. I’m surprised to find you arguing against that and suspect that data suggesting it isn’t true is either very limited or incredibly cherry picked.
Roth’s first linked article explains the benchmarking and analysis. As you state, the purpose of rebalancing is to “maintain risk at the preset level”. To maximize total expected returns, set the allocation at 100% equities; no rebalancing necessary. In this case the advisor can claim even greater value added than Vanguard’s 35bps.
Jim, to answer your question, the 50/50 portfolio that got to 70/30 might have had an average risk of 60/40 over that period. In other words, the average equity risk over that period would be closer to 60/40 than either the beginning or ending balances. But I agree the main purpose of rebalancing is to manage risk.
I agree a portfolio that gradually moves from 50/50 to 70/30 has an average risk of 60/40. I’m not sure I agree that’s the best comparison in this situation though since we’re trying to compare a rebalanced portfolio to a non-rebalanced one. Maybe instead of comparing 70/30 to 60/40 we should compare 60/40 to 50/50. But either way, I think the point has been made. Rebalancing between stocks and bonds lowers expected returns and risk. Now risk-adjusted returns? Probably not.
Great article! Appreciated the pros and cons analysis of both sides
When it comes to managing assets, those are good points to consider. But, I wonder how you quantify value added in other ways when working with an advisor? For example, my folks recently re-financed their mortgage, made $1000 in savings that way. Their loan officer recommended they use that extra savings to pay off the home in 11 years rather than the 15, which he suggested would be around $30-50k in savings. They loved the idea. However, over a 10 year time span if they invested that money elsewhere, it would be much more impactful than simply $30-50k. They had no idea that could be a $300-500k decision, depending on how aggressive they could be with that money in the same time frame. They didn’t even blink an eye until I punted that idea to them. Would you think a fee-based advisor would be worth it for that type of scenario, when someone doesn’t have the expertise or mindset to have insight beyond their status quo or gullibility? Kinda plays into the behavioral stuff, but more specifically in other pivotal financial decisions everyone faces at some point.