You know what you pay for gas or groceries, but do you know what you are paying in fees on your investments. More importantly, do you know the effect that these fees have on your investment performance and portfolio growth over time. Don’t worry if you said no, most people don’t. In fact, the financial services industry does its best to make sure you don’t notice, but I want to shine a light on the damage fees could be doing to your portfolio.
Traditionally, investment advisors have charged clients a fee based on the amount of assets they manage on the client’s behalf. Usually, this fee is around 1% of assets under management (AUM) but can vary higher or lower. While this may not seem like much, over a long period of time it can have significant effects on the value of your portfolio. According to Investor.gov, an SEC website dedicated to investor education, paying a 1% fee instead of .25% could result in 14% less in your portfolio over 20 years. In this article, Forbes illustrated the impact of a 1% fee on an 80% stock and 20% bond portfolio funded with a $10,000 deposit and $100 contributions every month over 45 years. They found that without fees the portfolio would be worth approximately $1.6 million, but the 1% fee reduced that amount by roughly $480,000, or 30%! I find the Forbes article particularly insightful because it mirrors an investment approach that could be implemented early in one’s career and utilized through retirement. In addition, many investment advisors utilize mutual funds or specialized ETFs with high expense ratios, that could further detract from your portfolio performance. The argument could be made that higher fees are justified if higher returns are produced, but the Forbes article found that more expensive, actively managed funds often lag that of less expensive competitors.
Advisors that charge based on AUM like to say that they do better when you do better, meaning that their fee increases or decreases based on the value of your portfolio. While this is certainly true, their fees also grow every time you make a deposit. If you are paying 1% of $1 million in AUM, you are paying $10,000 per year in fees to your advisor. If you made a $500,000 deposit, your fee would increase to $15,000 per year. Was any additional work done on your behalf? Also consider that advisors working under an AUM model are incented to gather assets, which is industry speak for getting clients to invest more dollars with them. Even if you are better off using the funds to pay down debt or invest in real estate, is that the advice you will receive?
Working with an advisor that charges an hourly fee could be an opportunity to save over the long run and ensure that the advice you are receiving is always in your best interest. Hourly fee advisors charge only for the time they are working on your account. During the first year, more time will likely be required whether they are creating a financial plan or setting up your portfolio. Depending on the advisor and the complexity of your financial situation, an hourly advisor may or may not save money in the first year versus an advisor charging based on AUM. You will likely see savings in the following years as your AUM fees increase, but fewer hours are required to rebalance your portfolio and review your investments. In addition, hourly fee advisors are paid only by the client for the advice they provide, and do not sell products like insurance or mutual funds. The advice they provide holds only your best interest in mind. Every advisor and every client situation are unique. Be sure to review any advisors services and fees before signing a contract.
When I began planning to launch Pape Financial, my intention was to be a trusted partner that helped my clients achieve their financial goals. I rejected both the AUM model and any other product sales so that I could be a fiduciary in the truest sense of the word. If you have questions about the fees you are currently paying, I offer a free no obligation analysis to help you understand. If you are interested, please schedule a time to chat.