Watch out for financial advisers charging excessive fees
The financial advisor I used to work with left and I’m looking for a new one. Someone recommended a financial advisor so I looked them up. They were paid just over 1 percent a year based on the value of the portfolio. I objected to the fee, but I don’t have much experience as I was with my former advisor for a long time. Is the fee normal?
It is not unusual for financial advisors to charge a percentage fee based on the total portfolio value. So, if the fee is 1 percent and your portfolio is $500,000, you’ll pay $5,000. This does not vary depending on performance. Whether you make or lose money in any given year, you’ll still pay the 1 percent fee.
If you’re just looking for investment management, 1 percent may be too high. I’ll start by giving you some context.
In the past, investing in the stock market often meant that you were buying shares of a particular company or giving your money to a fund to do it on your behalf. The idea was that they were experts who knew how to analyse, select and manage stocks, giving you a ‘good return’.
What is a good comeback? As a comparison, the average long-term return of the stock market as a whole is somewhere between 7 and 10 percent. In the past, some funds’ value proposition aimed to beat market returns.
But research shows that most people, including professionals, are not successful in beating the market average in the long run.
The real question is what are you paying for?
With this in mind, index funds emerged in the 70s. The proposition was: We won’t try to beat the market, we’ll just try to copy it. Why put in all that extra effort to try to achieve above-market returns when the odds of doing so are slim anyway?
The benefit of this approach (now known as ‘passive investing’) is that it requires less work. Index funds don’t have to research, analyze and select specific stocks and then constantly monitor them to decide whether it’s time to sell or buy. They’re just trying to replicate the market as a whole (or an index, to be more specific). This is a copy-paste strategy.
This allows them to reduce costs. Unlike funds that attempt to pick stocks (known as “active investing”), index funds and ETFs that aim to replicate a broad market index don’t need to do all the extra research involved in picking stocks. Less work means lower costs.
To give you some estimates, if you make your investments entirely yourself (i.e., sign up with a broker and buy them yourself), you will be able to reduce your management fees to under 0.2 percent.
If you sign up for an index fund or with a robo-advisor, you could be looking at a rate between 0.2 and 0.4 percent. But let’s say you pay 0.5 percent instead of 1 percent on a $500,000 portfolio that returns 7 percent over 20 years; the total impact of the fees on your portfolio would be about $183,000 (compared to $349,000 if you were paying 1 percent). That’s a difference of over $166,000.
Now, I said the ‘total impact’ of the fees is because the impact of the fees is greater than the fees you pay. Remember, you’re not just paying a fee; fees also reduce the total amount of money that can be deposited, which increases over time.
For example, 1 percent of $500,000 is $5,000; but if you pay half that ($2,250), that’s an extra $2,250 to deposit. So when you factor in this drag on portfolio growth, the total impact of fees is much larger than the amount paid.
There are also other costs (like taxes) you may pay. The more you pay in costs, the harder your investments have to work to get a good return net of costs.
All this means that if you’re just looking for portfolio management, there are much cheaper options. So the real question is: What are you paying for?
I don’t know enough about your situation. Maybe that company offers you additional services such as estate planning. Maybe you are paying the price for the quality of your relationship with that advisor.
Even if you’re getting good value, it’s worth asking whether it’s worth paying a percentage fee that you’ll continue to pay more each year as your portfolio grows.
However, if you have a fairly ordinary portfolio of ETFs and a few stocks, a fairly low-maintenance setup with no complex structures (e.g. trusts, companies, etc.) and don’t need a lot of ongoing advice, I would question whether you’re getting enough value to justify the premium.
Paridhi Jain is a money and mindset coach who combines practical strategies with mindset transformation to help clients create wealth, greater freedom and fulfillment in work and life. Find Paridhi on: skillsmart.com.au
- The advice given in this article is general in nature and is not intended to influence readers’ decisions about investments or financial products. They should always seek their own professional advice, taking into account their personal circumstances, before making any financial decisions.
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Paridhi Jain is a money and mindset coach who combines practical strategies with mindset transformation to help clients create wealth, greater freedom and fulfillment in work and life.
