31 Jul Are You Getting Soaked on Fees?
How much are your “all in” costs when working with an advisor? If you don’t know, you’ll want to figure it out.
I regularly meet with prospective clients who are shocked when I look at their statements and add up all the fees. In most cases, a good portion of their fees would be better spent on a first-class, five-star tropical vacation.
One of the strangest aspects of most wealth management fees is they are based solely on account size, with little correlation to the actual needs of the client. It is simple and transparent but tends to benefit clients with smaller balances or high utilizers of services. Higher-net-worth clients with typical service needs end up subsidizing those clients. The key to knowing if you’re getting soaked is to understand the components of your fee and the rationale.
The main components of wealth management costs are wealth advisory work, portfolio management, underlying managers, tax efficiency, and where the assets are held.
Wealth Advisory: This is all the financial planning, project management, and administrative work advisors do for clients. Ideally, this fee is customized to the actual needs and complexity of the client and is not based on assets under management.
Portfolio Management: Managing a portfolio involves setting a target, transitioning existing portfolio, rebalancing, tax-loss harvesting, asset location, manager/product selection and ongoing monitoring. In most cases this should be no more than .35% annually, and should be lower if you have more than $10 million invested.
Underlying Managers/Investment Products: For traditional investments, (stocks, bonds, liquid diversifiers) the weighted average fee should be less than .30%, possibly as low as .15%. Many wealth managers have weighted average underlying manager fees at .75% or higher! The reasoning is they expect these managers to provide downside protection or outperform. Unfortunately, the empirical evidence does not support the claim.
Tax Cost: This is that feeling at tax time when you owe more than you thought, and is primarily driven by wealth managers or underlying active managers making lots of tactical trades and not making tax-aware investing a priority. The tax cost ratio refers to the amount that an investor’s return is reduced by taxes that are paid. Ideally, the tax cost ratio should be .50% or less. It is not surprising to see tax cost ratios as high as 1% or more.
Platform: The good news is most custodians have been in a fee war, so it is unlikely you’re paying too much. The major custodians are also broker-dealers and cover their custody costs through transaction charges (commissions). In general, fees attributable to the custodian (whether commissions or other fees) should be under .05%, and probably less.
What should your “all in” fee be as a percentage of your investable assets?
According to a 2017 Planning Profession Fee Survey by Inside Information, the typical “all in” fees for a $5 million account, excluding tax costs, is 1.20%. However, I’ve commonly seen “all in” costs excluding taxes well over 1.5% for this level of assets. Assuming you have typical wealth advisory needs, “all in” fees should fall; $3 million or less: 1.25% or lower; $5 million: 1% or lower; $20 million: under .75%
In percentage terms, these differences seem small. However, if you’re paying .50% too much on a $5 million account, that’s $25,000 a year!
Even if you feel great about your advisory relationship, it’s important to understand the fees because we may be in a low-return environment for a while. Over the next decade, a number of experts are estimating that broadly diversified moderate risk portfolios may only see 6% average annual returns, and that may be high (as we keep saying, no one knows what the future will bring, and past performance is never a guarantee of future results). Let’s do the math using that hypothetical 6% to illustrate:
|High Cost||Low Cost|
|Gross Return, $5 million account||6.00%||6.00%|
|“All In” Costs, excluding taxes||-1.50%||-1.00%|
|Net Return to You %||1.00%||2.00%|
|Net Return to You $||50,000||100,000|
In some firms, most of the real return could be completely eaten by fees and taxes! This may be fine if they are able to consistently outperform the indexes and cover the taxes by a material amount. While this is possible, it is not probable.
Will your advisory fees create value?
It depends how you define value. If priced right, absolutely!
Today, each person must be their own insurance company, making sure their money will last their lifetime, ideally living fully along the way. Most people aren’t equipped to do this. It requires a comprehensive, proactive and knowledgeable approach.
The key thing you can do to improve your condition is to ask your advisor to show you the “all in” fees you are paying. Then, ask them how those fees relate to improving your condition. Wealth advisory and financial planning related fees usually have a high return on investment. Investment management related fees tend to have a much lower ROI. If you are paying a lot of taxes due to your portfolio and/or your advisor emphasizes active underlying managers, ask them to show you how you are performing relative to the indexes. I always tell clients to focus on what they can control, and this is something well within their ability to control that can make a tremendous impact on their outcomes.