The paradox of lower expected returns is that investors get scared investing their own money so they turn to professionals. In doing so, they’re often hiring high fee advisors or portfolio managers who might actually manage these assets better than they can on their own, however, what the manager puts in one pocket with better behavior and performance they take from the other pocket with their high fees. We even see this in the recent data. As more active managers fail to perform well advisory fees are on the rise. Investors are getting scared into the arms of high fee advisors who gladly slip their hands into your back pocket as they embrace you.
It’s been empirically proven that high fees can be the most destructive part of any financial plan. It’s also been shown that stocks tend to generate lower future returns when they’re richly valued. This means that high fees are likely to be magnified in the coming decade as aggregate returns are lower and high fees eat up a bigger portion of this lower return (what is a “high fee” you ask? In a world where some of the best funds and advisors cost less than 0.5% annually there’s no reason to pay more than that in my opinion).
Knowing how advisors and managers sell this high fee story is half the battle of avoiding the trap. And here’s how they’ll do it:
- They’ll tell you scary stories about how the next 2008 is right around the corner when the reality is that they have been predicting the next 2008 for most of their career (and they’ll probably even get it right once or twice as they destroy capital all the way inbetween!)
- They’ll tell you that they have a proprietary black box “quant” strategy when they really just did a whole lot of backtesting to fit the data to a set of performance figures that will sell well.
- They’ll sell you the allure of “market beating” returns speaking in an alpha/beta language they expect you to misunderstand.
- They’ll sell you a “tactical” strategy that is really nothing more than their attempt to look busy while they justify the high fees they charge.
- They’ll tell you you have to diversify into assets outside of stocks and bonds including gold, “alternatives” and other assets when the reality is that most of these assets are just high fee perennial underperformers.
- They’ll cite all the “empirical” research about the latest “factors” that generate outperformance when they’re really just selling you the hope of higher returns in exchange for the guarantee of higher fees.
In sum, if you hear the words “alternatives”, “factor investing”, “gold”, “tactical”, “quant”, “proprietary”, “market beating” or “2008” there’s a good chance you’re talking to someone who is going to guarantee you pay higher fees in exchange for the hope of higher returns (which they most likely won’t deliver).¹
¹ – Read Jason Zweig’s excellent new book “The Devil’s Dictionary” for a full list of the words the financial industry loves to confuse you with.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.