Advisory Fees
An investor’s chances of doing well in the financial markets are significantly improved if they keep advisory fees to a minimum. Over a long period, high management fees and related expenses can have a significant drag on wealth creation. Let’s examine the magnitude to which the cost of a financial advisor (even if they charge average advisory fees) impact a person’s wealth.
Paying average advisory fees is still destructive to wealth creation
The cost of financial advice is, in most cases, too high to be supportive of the investor growing his or her wealth in the long term.
- According to a study by AdvisoryHQ, the average fee for a financial advisor’s services is 1.02% of assets under management annually for an account of $1 million.
- The fees fall to about 0.70% for those with $10 million in assets.
- Another source, PriceMetrix, puts the average costs a little higher at around 1.25% for investors with $500,000 to $1 million under management.
Let’s say an investor has a 30-year investment timeline and $1 million to invest. Assume the average annual return of the portfolio is 6%.
- If an investor pays a 1% annual fee, the value of the portfolio in 30 years’ net of fees will be $4,321,942.
- If an advisor can reduce fees by 0.50% (50 basis points), the savings over 30 years will be a whopping $662,009.
Impact of financial advisor fees over time
To many, a 1% annual fee doesn’t sound like much, but the cumulative impact is often overlooked because fees eat away at portfolio value over time.
A study published in the Financial Analysts Journal titled “Fees Eat Diversification’s Lunch” by William W. Jennings and Brian C. Payne shows that diversification loses its benefits when investment costs are high. The authors refer to an editorial by Charles Ellis published in the Financial Analysts Journal that showed active investment management fees are extremely high.
Building on that, the authors examine the relationship between asset class allocation and fees. They conclude the majority of the excess return gained by allocation decreases significantly when fees are applied.
Although diversification is one of the most important drivers of managing risk in an investment portfolio, it should not come at the expense of high fees, especially if the fees eat up most of the benefits.
Fee-only vs fee-based advisors – which costs more?
SEI’s Fees at a Crossroad study published in 2018 examined the fees structures of financial advisors and revisited the debate between “fee-only” and “fee-based” advisors.
Some key takeaways are:
- Investors are becoming more fee-savvy
- There is a push for financial advisors to deliver a professional service model similar to the legal and accounting profession where the advisor works directly for the client and there are no conflicts.
- The study compared results taken in 2018 to the first study in 2015. They found that investors are thinking more about fees now and how advisors charge for their services.
- Furthermore, nearly one-third of investors would leave their advisor if they felt fees were too high.
In 2015, the White House Council of Economic Advisers determined that Americans could be losing an estimated $17 billion a year as a result of financial advisors recommending investment products with high costs and low returns, with hidden incentives being offered to those recommending those investments. The conclusion of the findings was that conflicts of interest are eroding the savings of many investors.
Advisory fees matter
Advisory fees may not seem like a big deal to many, but they can add up over time. Investing and quality advice aren’t free, but investors can drive expenses down to a fair and reasonable level, which can help improve investment performance over time.
We are a financial advisor in Philadelphia providing fee-only, objective advice to our clients. We carry out our investment strategies using low-cost ETFs for our clients. If you would like to discuss a possible relationship, contact us.
Sources
Anderson, John D., Veres, Bob, and Lee, Raef. SEI. Fees at a Crossroads.
Fontinelle, Amy. (2021, February 7th). How to Cut Financial Advisor Expenses. Investopedia.
Harris, Benjamin. (2018, February 7th). How Do Your Financial Adviser’s Fees Compare? Good Luck Figuring It Out. The Wall Street Journal.
Jennings, W.W., & Payne, B.C. (2016). Fees Eat Diversification’s Lunch. Financial Analysts Journal, 72, 31 - 40.
The White House. Office of the Press Secretary. (2016, April 6). Fact Sheet: Middle Class Economics: Strengthening Retirement Security by Cracking Down on Conflicts of Interest in Retirement Savings.