An investor with a $1 million portfolio will lose 25% of their total investment returns due to advisor fees!! In dollar terms that is $717,000.
-Tim Brennan, Ariadne Wealth Advisors
Here’s the math…
0% advisory fees (buy-and-hold low-cost funds)
- Over 20 years, $1M growing at 7% per year = $3.9M
1% advisory fees (using low-cost ETF’s and never generating capital gains)
- Over 20 years, $1M growing at 7% per year (minus fees) = $3.1M
- The cumulative cost is 25% of the investor’s total investment return.
However, based on my own personal experience, advisors who are brazen enough to charge 1% in fees annually also use actively managed mutual funds or separately managed accounts that generate high capital gains taxes from buying and selling (in a futile attempt to beat benchmarks). When they do this, the math gets REALLY ugly:
1% advisory fees (using actively managed funds or separately managed accounts that cost another 1% and generating capital gains taxes due to frequent buying/selling 0.5%-1%)
- Over 20 years, $1M growing at 7% per year (minus fees & taxes) = $2.2M
- The cumulative cost is 60% of the investor’s total investment return.
- If returns are closer to 5% per year as predicted, then the cumulative cost rises to a whopping 70% of the investor’s total investment return as there is less return to share with the middlemen.
The dirty little secret is that it is just as easy to manage a big portfolio as it is a small portfolio.
It is equally efficient to buy 100 shares of VTI (the Vanguard Total Stock Market Index ETF) as it is to buy 500 shares or 5000 shares. Does it take more time to buy more shares? No! It takes less than 10 seconds, regardless of how many shares you buy. Does it cost more to buy/sell more shares? No! At Vanguard, the commission to buy/sell 100 shares of VTI is $0, and the commission to buy/sell 10,000 shares of VTI is $0.
So, for once, size doesn’t matter.
To give you some idea of how ridiculous the “fee-based” model is, consider the following:
- My CPA charges by the hour and gives me an itemized bill.
- My attorney charges by the hour and gives me an itemized bill.
- My plumber charges by the hour (plus parts) and gives me an itemized bill.
- My electrician charges by the hour (plus parts) and gives me an itemized bill.
- My auto mechanic charges by the hour (plus parts) and gives me an itemized bill.
- My dentist charges me per procedure and gives me an itemized bill.
- My dog walker charges per visit and gives me an itemized poop report.
Imagine if your doctor charged you 1% of your assets to keep you alive and then got kickbacks for prescribing you the most expensive medicines. Would you agree to that?
So when you hire help for your investments, please don’t give your financial advisor full access to your accounts and allow them to help themselves to advisory fees. If you owe fees, you should get an invoice, study it carefully, and then write a check after the service has been rendered, just like you do with every other professional that you hire.
You can find financial advisors committed to a fee-only model here: http://www.napfa.org/