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Hi Cullen,

Having worked in the investment advisory world for a few years now my perspective on fees has definitely shifted from “they are always and everywhere bad,” to “there is some very real value in hiring a financial advisor.” Call it the ignorance of the masses, but many people are actually quite comfortable paying 1-2% in advisory fees (on top of fund fees!) to have the assurance that someone is watching out for them. Regardless of how true that assumption is, many of our clients simply don’t want to think about their investments, so they are quite comfortable to hand them off to a human advisor. We even have a client (HNW & very financially savvy) who receives a customized, quarterly statement showing nominal fees. This client has remained a faithful client for many years and obviously feels that the relationship is worth the 1% advisory fee.

In critiquing fees, would it not be slightly more beneficial to attack the “1-2% advisory + mutual fund fees” models that are still quite popular? At the end of the day, an advisor who is charging 1% for comprehensive financial planning on top of low-cost ETFs is actually pretty competitive. I honestly don’t see “all in” fees getting much lower than 1.3% for holistic, customized financial advice (maybe lower for > $2,000,000 in AUM). Simply because the economics of being an advisor don’t work. Now if we’re talking pure asset management, that’s a different story. And perhaps that’s where you were going with the recent post on fees.

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Posted by Erestor
Posted on 03/07/2017 11:39 AM
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Hi Erestor. I know I am in kind of a unique position with my business model, but here’s how I think of this. Imagine having $1,000,000 and a 1% advisor and once a year you have to go meet with him. Before you do that though you have to take $10,000 out of the bank and leave it at the meeting. And you do this once a year.

Now, ask yourself what other type of advisor in your life charges a fee like that? You don’t pay your accountant that much. Or your lawyer. Or your personal trainer. Maybe not even your doctor except in unusual circumstances.

But here’s the bigger thing – it’s my opinion that financial advisors don’t do that much in the first place. Yeah, there’s usually some upfront and recurring planning, but it’s not like that takes that long. The portfolio management is customized, takes some know-how and can be onerous to manage since many clients have bad behavior, but it’s not rocket science and most advisors are actually building portfolios that are detrimental when compared to index funds. And that’s where this is getting really problematic for the 1% advisor – the competition is offering equal services for much lower costs. I mean, I doubt there are many advisors doing more than Vanguard’s Robo with its planning service attached and that costs 35 bps or something. It’s a plain vanilla strategy, but still.

So you have this huge hole opening up between the low cost options and the 1% advisors, but the services aren’t that different. And so the value proposition of the 1% advisor has definitely been diminished.

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Cullen Roche Posted by Cullen Roche
Answered on 03/07/2017 12:52 PM
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    I think the criticisms of advisors fee are correct and, in fact, highly UNDERESTIMATE the effect.
    I have a friend, now retired, who moved all her accounts to a financial advisor because of a family connection (he is her nephew). He said that, because she is “family he will only charge her 1% annually and then he promptly put most of her money into funds that have a 1% annual fee.
    So that’s 2% annually.
    Now, my friend follows the advice to spend out here retirement savings at approximately 4% a year. So, every year she takes out about 4% of her funds and her nephew costs her 2%.
    In other words. For every two dollars of her life savings that she pulls out, her nephew pulls out one. You can say that is 2%… or you can say it is ONE THIRD. It’s true that she gets some service for her money, buy are they worth ONE THIRD of her savings???

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    Posted by Steve Schuller
    Answered on 03/07/2017 1:42 PM
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      Yeah, I agree Steve. The 1% figure is just so magnified when you consider the long-term impact. I mean, if the average portfolio is about 50/50 and that portfolio generates about 6% per year (10% from stocks and 2% from bonds) then the 1% advisor fee is eating 16% of every dollar earned.

      Now, I’ve been in the business long enough to know that A LOT of people can use an advisor. In fact, most probably need one even if they think they don't. Not just for planning, but for guidance along the way. Most people will not stick to a long-term plan that’s appropriate for them. They need guidance. I view my job more like a personal trainer than anything else. I won’t turn you into the next Mr. Olympia, but I will make sure you build the right plan and stick with it through thick and thin. What is that worth? Well, according to my pricing structure it’s worth about 0.35%. Some people might be willing to pay more. But it’s very hard for 1% advisors to argue that they’re providing more service and value than many of the other low cost providers out there. Between myself, the flat fee advisors, Vanguard, the Robos, etc it’s just very hard to see how the 1% advisory fee can continue to exist….

      :-)

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      Cullen Roche Posted by Cullen Roche
      Answered on 03/07/2017 2:01 PM
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        What I am coming to believe is that in theory, fees are too high, but in practice, they’re not. As weird as that sounds. So many people live under the impression that a high quality financial advisor is high priced. Attempting to offer advisory services at some sort of “value breakpoint” seems to strike many affluent investors as cheap. Perhaps the millennial investors will see things differently, but we’re still a couple decades away from millennials having that kind of money.

        Personally, I don’t think anyone with $500,000 (maybe even $1,000,000) or less even needs an advisor. Someone should start offering low-cost financial planning without the asset management piece. I’ve even thought of launching something similar myself. Learnvest is doing it, and I think there’s a market there. The planning aspect doesn’t usually become too complex until you’re over $1,000,000 in household AUM. But at that point a good advisor can become invaluable to a client’s psyche, and therein lies the perception of value. I guess that would be my main point: an advisor’s value is not easily translated into dollar terms. The advisor-client relationship is grounded primarily in mutual trust, not “a good deal.” Can that trust be misplaced at times? Sure. But overall, at least in the private client world, people don’t seem all that flustered about the fees.

        So to summarize I would say that the value add for 1% fee FAs servicing accounts from $250K – $1MM is diminishing. However, clients with more than $1MM don’t seem to be terribly upset and are even quite willing to pay the 1%. To me, some of the fee debate comes down theory vs. reality. In theory, these fees should be egregious because the math on compounding returns is so clear. But in practice, investors are pretty slow in adopting the low-fee options, if they’re even interested in them at all.

        On a side note, there is one group of people who might be as unregulated and opaque in their value as FAs: Car Mechanics. Something like 0.5% of the population knows enough to comprehend the jargon that gets tossed their way during a vehicle inspection. Then at the end, the client is legally obligated to pay basically whatever the mechanic decides they need to pay. Add to that the egregious labor costs and I think there are some nice similarities.

        That’s just for fun. ? But it crossed my mind the other day as a loose parallel…

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        Posted by Erestor
        Answered on 03/08/2017 5:25 PM
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          “Personally, I don’t think anyone with $500,000 (maybe even $1,000,000) or less even needs an advisor.” I would argue that people with less than $500,000 needs an adviser more than those with more money. A lot of people cannot even get any advice if they have less than $100,000 and are ripe targets for bad investments.

          “people don’t seem all that flustered about the fees” That is usually because they do not understand the bite that fees take out of their savings. Often the client takes the risk and the adviser gets a 2% basically risk-fee return on the principal regardless of performance.

          Whether the clients understands fees is irrelevant to the adviser’s fiduciary duty to see to the client’s best interests.

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          Posted by Lucas
          Answered on 03/08/2017 8:19 PM
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            I’ve commented on this before. I’ve known my financial advisor since I was 4 so we have lifelong personal and family connections. I pay 0.75% on ca. $4 million. It’s lot of money to pay out. But we own almost all individual securities so there is no additional overhead and we can somewhat control the ratio of dividends to capital gains for tax purposes. Additionally he has 30+ years experience in the Muni bond market. The stock part I could do a good job with, but the Muni part takes skills I don’t have.

            As Cullen points out, bonds are important, and the math favors owning actual bonds over bond funds. Muni bonds are complex because of the payment flows (GO, Property Tax, parking, ….) and the small size of many issues.

            I’m willing to pay 0.75% for the personal service, the tax planning, and the muni bond expertise. Yes, it’s the same as paying someone $15/hr for full time work ($30,000/yr). My extended family (and my financial advisor) do not understand why I am unable to hire housecleaning and why I drive a 2006 Honda Odyssey. But there is psychological value in having someone you trust handle your savings. YMMV.

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            Posted by John Daschbach
            Answered on 03/08/2017 8:43 PM
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              I had a 401 (k) at work and never gave it much thought, having been born to a low-income family where stocks weren’t even on the radar. I just assumed the 401 (k) built up over time through some mysterious process where smart folks in suits played with your money. Then I started my own business and invested with Edward Jones (again, a guy in a suit who met with us once a year and made us feel smart.)

              Then I started educating myself, looking at fees, understanding just as much as I needed (learned enough to realize I was not that smart and was better off aiming for the average instead of trading.) I started a Vanguard account while keeping the Edward Jones account). After recognizing a couple of mistakes where the Edward Jones adviser was acting in his best interests instead of mine–most notably letting me buy a college savings fund with a 5 percent load when I could’ve bought a state 529 fund and saved that 5 percent in state taxes–I eventually flipped all my accounts into Vanguard. The biggest trigger was my EJ funds lost 2 percent in 2015 while my diversified Vanguard funds gained a percent. Even though a year is not a fair period to judge performance, I quickly realized it was fees alone that made much of the difference.

              When I rolled over all the mutual funds, I spent the time really digging in to see there was no rhyme or reason to the allocations, and a lot of overlap. Of course I know EJ gets kickbacks on certain funds, which happened to be the ones I was in, but the biggest insult was the 12b-1 fund. Here I was paying more for them to market their fund than I was paying for any of my Vanguard funds in total.

              In short, I think the big problem with 1 percent (as clearly stated by the OP) is that it hardly seems enough FOR THE ADVISER, but seems like way too much for most individual investors. We’ll see who wins that battle. Indeed, I think we already see. That said, I’d be happy to work with a fee-only adviser, but all the ones I meet with keep wanting to slide me into some commission thing. In the meantime, I will just keep my diversified Vanguard indexes with a total expense ratio of less than 0.1.

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              Posted by Scott Nicholson
              Answered on 03/15/2017 11:36 AM
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                It’s an all too common story Scott. The incentive structure in finance drives a lot of advisors to act more like salespeople than real advisors. They’re always pushing to hit certain firm targets. And a lot of this results in doing things that aren’t in your best interest.

                The story that changed my career was when I was a young rep at Merrill working on a big team. I asked my boss why we use these high fee American Funds mutual funds when the iShares ETFs are exact equivalents in terms of performance, but much more tax and fee efficient. He said “we don’t make money to sell free stuff”. That never sat well with me and it explains why I couldn’t last very long at a big firm like that. I couldn’t sell people things I didn’t believe in.

                Unfortunately, you have to be in a pretty unique situation to do what I am doing. I am self employed running a mostly automated online advisory business. Oh, and I don’t have some need to get ultra rich so charging a low fee isn’t a big deal for me. But I suspect that most of Wall Street can’t operate like this. So the fee structure remains upside down because a lot of these legacy businesses can’t cut their costs because they have old school style businesses. And it could take a generation for them to go away because the older generations often times don’t realize/care that there are low fee automated equivalents.

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                Cullen Roche Posted by Cullen Roche
                Answered on 03/15/2017 11:59 AM
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                  I don’t dispute the notion that the 1-1.5% charged by many advisors (on top of whatever internal fees the funds and/or ETFs have) is not necessarily a good deal, especially if we’re talking only about asset management.

                  I do feel that some advisors provide more services and thus more value than many of the low-cost offerings. I don’t mean this as a criticism to your offering, Cullen. (and I don’t know what other services you provide besides portfolio management.)

                  What value should we assign to advisors that do a good job of steering clients away from bad investor habits, such as chasing hot sectors or panicking out of the market? What about creating a thorough financial plan, including wealth transfer strategies, charitable giving strategies and life insurance reviews? What about conference calls (or meetings) with the client’s tax professionals and estate planning attorneys? Do the annual reviews go beyond portfolio performance and delve back in to the financial plan to see if updates are needed? Tax efficiency is something Cullen has (rightly) touched on many times – but what does that mean? Does the advisor pro-actively contact the client and determine if there might be other reasons to harvest gains or losses each year? Getting back to financial plan reviews, does the client trust the advisor enough to ask for advice on a 15 year vs. 30 year mortgage, or about leasing a car vs. buying a car?

                  I realize that there are other ways for advisors to charge ancillary services – such as a flat fee for a project or hourly fees. I would also say that some advisors are frequently providing more than just portfolio management including tax-aware rebalancing – and charging 1% may not be such a bad deal for clients.

                  I’ll admit that my perspective may be different because my practice is in Florida and most of my clients are old. The personal relationship – which also means meeting with me and my team – is important to them. Most of them got comfortable with using personal computers years ago, but relying only on a stranger at 1-800 tech support if they need help viewing their accounts online isn’t their style. This is one example of why my staff needs are likely different than an advisor running a mostly automated online advisory business.

                  Having said all that – there’s no doubt that fee compression is a reality – and in many instances, a case can be made that financial advisors are not earning their 1-1.5% I used to work at Merrill Lynch too- and when I first joined back in 2001, a very successful team in my branch was charging the full-boat 3% for the equity SMA accounts (managed by 3rd parties). Those days are over.

                  Finally, all advisors are (it seems to me) sales people – at least at times. By that I mean an advisor (or advisory firm) is in the business of gathering. On one extreme, the very low-cost and efficient firm needs lots of assets. On the other extreme, the super high touch, high level of comprehensive planning and asset management service can get away with charging more than 35 bps. In each example, there must be a value proposition that is effectively communicated to either gather enough assets or gather enough clients willing to pay. It’s all selling/marketing.

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                  Posted by Steve W
                  Answered on 03/15/2017 4:48 PM
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                    A salesperson is needed when there is excess supply of a good/service that is inflated in value. Ie, the market does not clear solely based on demand. The goods/services must be pushed to the end consumer to create a demand where there otherwise wasn’t any.

                    Most of the financial services industry is a sales business. We are selling things that people don’t need because the value is inflated relative to all other available options. Vanguard doesn’t “sell” their services because there is a natural demand for their products since they have become the marginal price setter for products of a certain value. A firm like Merrill Lynch, on the other hand, must sell their products and services to prove that they are valuable to people relative to the marginal price setter.

                    In my business the equivalent product/service is Vanguard’s robo with an advisor. It costs roughly 0.35%. My service will cost a little bit more than that, but you get the human element across a slightly more personalized portfolio. Is it worth it? Depends on the investor. Do I “sell” my service though? Actually, I have not solicited a single client since I started Orcam. Hence, there is a natural demand for my services because I have aligned myself with the marginal price setter of equivalent services. That’s why I don’t have to “sell” myself to people. There is a natural demand for the service because it’s everything the equivalent Vanguard service is with an added personalized touch. Most asset managers can't compete at this level of cost because they have too much overhead and no ability to scale as efficiently as Vanguard. And they have to justify all that overhead by selling their service at a premium. Personally, I think the overhead is a waste and results in a lower value service because the costs get passed along....That and, I don't really care about making humongous profits because I don't need the money that badly. Hence my ability to compete at such a low price point.

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                    Cullen Roche Posted by Cullen Roche
                    Answered on 03/15/2017 5:02 PM
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                      Well, perhaps it is a matter of semantics. I’ll substitute “marketing” for “selling”. Vanguard spreads the word about low-cost index investing. We have all seen Vanguard ads – that is marketing – which helps attract customers. For years, John Bogle has agreed to be interviewed on TV and in various publications – and that too is marketing. He sells the unique culture of Vanguard – not just the merits of index funds.

                      You (Orcam) are utilizing the web and your blog (Pragmatic Capitalist) has helped spread the word about Orcam. That is marketing – or selling. It’s just different than selling in person, like some on your team at Merrill did years ago. Your internet marketing efforts are just a different way to attract attention – to solicit. The personalized touch you offer is part of your sales process – it helps build your reputation, which helps you retain clients and gather more assets.

                      By no means am I criticizing Vanguard or Orcam or you. My main point in my previous comment is that some advisors – like me – are providing some additional value added services that the Vanguard robo offering probably does not. Whether those additional personal services are worth an extra 65 – 115 bps is an important question. As I said, fee compression is real. Advisors in the more traditional channels that are not working hard to provide real added value for their clients (not just asset management) will likely either change their practices dramatically in the coming years, or change their occupations.

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                      Posted by Steve W
                      Answered on 03/16/2017 11:04 AM
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                        Yeah, I know you’re not criticizing and I hope my comments don’t come across as overly critical either. There is definitely a place for higher fee advisors.

                        I guess my point is, for comparable services, there is a real economic distinction between something that needs to be sold and something that there is a natural demand for. By your definition the mere existence of a product offering means it must be “sold”. That’s true if we mean that buyers must know something is being sold before they can buy it. But that’s also a silly definition.

                        For instance, water is something that there is a natural demand for. It does not need to be “sold”. However, purified water needs to be “sold” because there is an excess supply of water at this inflated value. The seller of this product needs to create a demand for it that is above what its comparable natural rate would be.

                        When I worked at Merrill I had to “sell” my services as though we were doing something above and beyond what a comparable service does. That’s because we were selling a product of excess supply at an inflated value.

                        I would argue that what Vanguard and myself offer are not actually sales products. They sell themselves because they are close substitutes for the marginal price of these services. On the other hand, someone selling asset management and basic planning services at 1% per year has to sell the idea that they’re doing something above and beyond what I do or what Vanguard does. That’s because its supply is at an inflated value relative to comparable offerings.

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                        Cullen Roche Posted by Cullen Roche
                        Answered on 03/16/2017 1:03 PM
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                          What is not clear to me why fees are always calculated as a percentage. If I bring my car for new wheels to the repair shop, the wheels are not billed as a percentage of the value of my car are they? The same way, if I go to a financial advisor and after a few hours of research and talk, profiling my specific situation he invests my money for my pension in some stocks and bonds. Why would I need to pay him 1%? If I invest $1000, the financial advisor will only make $10. If I bring in $100.000.000 he just made a whopping 1 million for a couple of hours of work. Doesn’t make sense.

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                          Posted by Matthijs
                          Answered on 03/25/2017 2:28 PM
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                            It’s a matter of scale. A tire salesman can charge $100 for each tire regardless of how big his customers. But a portfolio manager can’t charge $100 for each portfolio because each portfolio is totally different. Some are really really big. So, it makes no sense to manage a $1MM portfolio for $100 a year and also manage a $10MM portfolio for $100 a year. I mean, if that was how Vanguard ran their business then Goldman Sachs would put all of their assets into a single LLC and ask Vanguard to manage it as one portfolio.

                            So, it’s a matter of scale. You can’t run a profitable financial firm without scale. And no one with significant assets can afford to manage them for a flat fee because they’d be taken advantage of. Unfortunately, the business is scaled around larger players so they are the marginal price setter. As a result, the marginal price setter sets prices by setting a % of AUM structure because that’s the only way they can make money. Everyone else follows suit because the marginal price setter sets their price that way.

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                            Cullen Roche Posted by Cullen Roche
                            Answered on 03/25/2017 5:51 PM
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                              Thanks for your reply Cullen. It’s still difficult to understand though. Of course I understand that a financial advisor helping out a small client with a 100k pension fund charges less then a financial advisor helping a big client with 100 million fund. There’s more work and responsibility in the second case.

                              But the total lack of relation between actual work being done and the amount of money charged puzzles me.

                              If a financial advisor has a single rich client with a 10 million portfolio and charging 1%, he makes 100k, already a very decent income. Two of those clients and you earn enough to be rich. Does the advisor really spend 150 days full time working on the portfolio of each client?

                              Why is there no competition driving down the % of costs a lot more? Why is there no competition of advisors charging just an hourly rate, therefore being cheaper and more competitive than other advisors charging 1%?

                              I’m also in a service industry (IT). I build products. Of course I charge big clients more. But mostly I charge based on time and effort put in. Say I build a website for 5k for a client. If I would charge money as a percentage of the clients worth I would have to charge 50k. I’d immediately lose the clients to my competition, charging a normal, fixed or time based fee.

                              I don’t understand why the financial service industry should be different from my IT service industry.

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                              Posted by Matthijs
                              Answered on 03/26/2017 3:19 AM
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                                I don’t think there’s a lot of advisors with 2 clients making 200K a year.

                                But I think you’re referring to two different businesses really. There’s real portfolio managers and then there’s financial advisors. The cost of portfolio management is coming down substantially as Vanguard devours the world. The cost of financial advisory, however, isn’t coming down as quickly. I think the reason why is that it’s much more difficult to assess how much value the advisor adds. For instance, if you’re an advisor managing 100MM with 100 clients and you provide planning services as well then you’re doing quite a bit of work. But how valuable is the planning vs the asset management? It’s hard to say.

                                Personally, I think it’s WAY below 1%. That’s why my fee is 0.35%. I believe wholeheartedly that I’ve skated to where the puck is going. But I don’t know. A lot of people still pay 1% per year so I am either an idiot or I am way ahead of the puck here….

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                                Cullen Roche Posted by Cullen Roche
                                Answered on 03/27/2017 12:21 AM
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                                  You are not an idiot. A lot of clients try to justify the high fees they are paying because they do not want to conclude that they themselves are idiots. It is a variation of the sunk cost fallacy.

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                                  Posted by Lucas
                                  Answered on 03/27/2017 1:47 PM
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                                    If you are not providing this to clients, you are charging too much…

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                                      Posted by MachineGhost
                                      Answered on 03/29/2017 12:31 AM
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