How to Pay For Financial Advice
There is a detailed article in today’s WSJ about ways to pay for financial advice. This has been an ongoing discussion topic amongst me and a small group of colleagues for years now.
I do have a few thoughts about your choice of fee structures; they range as follows:
• 2% & 20%
• Commission
• Percentage
• Flat rate
• Do it yourself
These each have advantages and disadvantages, along with some specific peculiarities. Decisions investors make should be a function of their understanding of what is involved in agreeing to pay for finance advice.
A quick review of each shows their strengths and weaknesses.
2% & 20% is primarily used by hedge funds. You pay a hefty premium plus one fifth of your profits for the privilege (many funds have an extended lock up period as well). Unfortunately, performance at funds has been lacking.
Bottom line: Top managers earn their fees, but the rest, not so much. If your manager(s) are making you outsized profits and avoiding the crackups, stay with them. Otherwise, rethink the fees you pay for under-performance
Commission driven is my least favorite of all the structures. Fees tend towards 4 or 5%, as brokers must constantly spin assets to generate revenue.
Bottomline: I simply do not understand how this business continues to exist . . .
Percentage basis is my preference how to conduct fin planning (and how I do my asset management work); Adviser is on the same side of the table as the client — no commissions, no compromised payments, no legal kickbacks from 3rd parties. If I am doing my job, I am helping clients plan for the future, avoid major drawdowns where possible, and capture upside.
Bottomline: Work with someone you are comfortable with to develop a plan for you; you should be able to tap someone for advice on a wide range of finance related issues. Your job is to manage someone else who does the day to day work.
Flat rate is a business model that I believe warrants further exploration. It has typically been used for accounts sized under $500k; Numerous firms offer this; they all seem bedeviled by under-performance and de minimus customer service. I believe this is an area that has potential for huge growth if someone can figure out a way to radically improve the performance problem.
Bottomline: One day . . .
Do it yourself is something I have long advocated for, but with some caveats: Dollar cost averaging into a handful of broad indices on a monthly basis is how you start; overlay a risk management approach (like the 10 month moving average) and you are onto something very doable. The downside is your own cognitive biases, the tendency to be overwhelmed by the daily noise, and a lack of discipline in following through on your own plan.
Bottomline: Very doable if you know who you are and have the ability to follow through.
There are numerous ways to get good financial planning advice at a variety of fee levels. Figure out what works best for your personal circumstances before committing to any one fee structure.
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Source:
How to Pay Your Financial Adviser
DAISY MAXEY
WSJ Special Report DECEMBER 12, 2011
http://online.wsj.com/article/SB10001424052970204554204577024152103830414.html
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December 12th, 2011 at 8:27 am
Everyone has a plan until they get whacked. Its amazing how you can plan something out, take a couple of hits, and forget what they hell you were trying to do. Then you look back and go Doh! I followed a plan for over a year, averaging in, and the at the ’09 bottom flushed everything. I had titanic loses. Luckily the market hung around for about 2 days, and actually went a little lower. I thought ‘I’m f’in again’. Only it was a really big screw up this time. Piled into SSO just before things went nuts to the upside. I was blowing my diaper out all the way up as I had to fight the overwhelming urge to sell too soon. And of course, when I got back to even, there was a hair raising correction that sent SSO plunging 15%!
December 12th, 2011 at 9:37 am
Personal experience:
Dollar cost averaging for five decades has done me well. Never touched and never waivering. Don’t see how this strategy can be beat by the common man.
~~~
BR: The key is having the discipline to keep pumping money into a freefalling market when every instinct sends you running in the opposite direction.
December 12th, 2011 at 9:57 am
In close to 25 years of investing, I’ve tried managers/advisers with all of those structures. And all along, I’ve also had some side funds that I managed myself. I agree that a percentage fee is probably the best or at least the most fair to the investor.
But after 4-5 years, it started to become clear that I was doing better for myself than with any of the managers. I went all-in on “my shoulders” about 10 years ago, and have never looked back.
Yes, I’ve had 2-3 years back to back where I was completely in the red (on paper). But I couldn’t have cared less. I think that is one of the areas where an individual investor can have an advantage.
One area where I still rely on professionals is in tax advice and planning. That stuff is beyond logic. That advice is almost always fee based, but I can’t think of a single case where they haven’t saved me more than the fees. When I look at that as an investment itself, the return is phenomenal.
December 12th, 2011 at 9:59 am
I am a DIY-er, partially because I enjoy it, but partically because I am not already a millionaire, and therefore of little interest to most asset management firms – at least, with reasonable fees. The flat rate tends to be a high percentage of assets under management.
A percentage basis strikes me as the only way to go, if I were to manage assets or have mine managed. It appears to be best in terms of conflict of interest.
December 12th, 2011 at 10:02 am
As one of those horrid people who still charges a commission to his clients for each trade, I feel I am providing the most cost effective method. If a firm is charging a 1% fee for assets under management, any time the market goes up 5%, the investor has just handed 20% of his profits to the manager. And a lot of these “wealth managers” do little more than stuff their clients portfolios with target date funds, sub performing mutual funds, and worst of all, annuities, that provide additional fee income (which, starting in 2012, will now have to be disclosed thanks to Dodd-Frank) to the “advisor” and can’t get out of their way when it comes to keeping abreast of market index performance.
By charging a commission, my feeling is that a service is rendered, and a price for that service is paid. Now, if you’re an unscrupulous churn artist, naturally this model does not provide value for the client. But no compensation structure will satisfy someone who is unscrupulous to begin with, and that, to me, is our industry’s main problem.
~~~
BR: Your math is wrong.
Lets start with $100k. 1% fee is 1k. If the market goes up 5%, and the account is now worth 5% more — that’s $5k — the additional fee is 1% of the $5k, or $50.
Unless I am misunderstanding your point . . .
December 12th, 2011 at 10:13 am
Decent assessment of 2/20 along with commission are both scams, minus a few folks that get lucky with the right hedge fund or trader.
But, I see lots of bias in the Percentage basis fee approach because leads the advisers to follow the market +/- a few percentage points just to keep a client “in” so fees can be collected. Let’s say you have have $500k account with a 2% fee, if it returns 10% than you pay $11k in fees but if it looses 10% you are down to $450 and the adviser still makes $9k in fees, not a ton of difference for the advising firm (which is why advisers call customer and “beg” them to stay in after a big downturn)… they need the fees!. Plus, if you returned 10% the 2% fee is still 22% of total gains a huge number, in a good year of returns let alone a more modest return or downturn.
I would like to see a model that truly puts adviser in the same boat as the investor, a huge revenue impact for losses. Maybe a small admin fee of .25% then 15% of gains… something of a rational hedge fund model. But, it won’t happen % fees are the backbone of the industry and it give only the client the real “market” risk.
I will stick w/ the do it yourself approach or work w/ firms like vanguard with really have low fee structures compared to the industry.
December 12th, 2011 at 10:38 am
This is a very helpful rundown. Thank you. Sharing it with others.
December 12th, 2011 at 10:56 am
2/20 is expensive. You are paying the guy to beat the benchmark to begin with, why give him 20% of the profits? 2/20 without a highwater mark is insanity. Now he gets paid to maixmize return without regard to risk. Heads he wins tail you lose. Fee for service, like any other professional, is the best model. It best aligns interests.
@newulm55
Who the hell pays 2%? You have to be completely braindead to pay 2%.
December 12th, 2011 at 11:08 am
I think the best approach is to have a substantial part of the compensation tied into performance of the investments. But there are issues with that also. Do you link to monthly, annual, or longer performance periods. If it is annual you may have given an incentive for high short-term performance with bad years in between. Sort of what we have done with CEO’s in many companies. But if it is all based on performance you may attract the wrong type of (gambling) personalities.
December 12th, 2011 at 12:01 pm
I agree. Fee only (% AUM) is the only way to go. It’s how I charge my clients too.
December 12th, 2011 at 2:39 pm
“The downside is your own cognitive biases, the tendency to be overwhelmed by the daily noise, and a lack of discipline in following through on your own plan.”
Am I to conclude from this that financial advisors do not have cognitive biases, are not overwhelmed by daily noise and have iron discipline?
~~~
BR: Some do, some don’t. My experience is that a decent professional adviser is going to have more discipline than the average Mom & Pop investor. YMMV
December 12th, 2011 at 2:45 pm
This conversation is very timely for me. A regular Jane. Started with an independent CFP in 2006 and gave him $800K. 5 years later I still have $800K but he now has $40K (very diversified, moderate risk portolio) from his 1% fee. Given the market from 06-11, would he be considered average, above average, bad? I’m seriously considering a change, but do not feel comfortable managing it myself. These other options don’t sound good either. I like the idea that in bad years, he gets paid less. I asked him to move me to all cash in June (no fee), but I can’t stay there forever. Managing it by myself makes me feel like I’m on a deserted island and there’s nobody to tell me the tsunami is coming.
December 12th, 2011 at 3:41 pm
It IS an “additional” fee, in addition to the charge on the initial corpus of the portfolio- but what is the deal with the recurring income on the existing AUM?
The account could be dead money for years on end, with the advisor taking a cut each year. Now some advisors- and I presume you are one of them- do quite a bit of active management and work to acheive goals, protect assets and beat the market.
But most practitioners are NOT Barry Ritholtz- they’re people who are little more than “asset gatherers” who act as conduits for mutual fund companies and insurance company “investment products.” That’s what real retail is like for the average investor. We see this model deployed in the 401(k) space as well, but thanks to Dodd-Frank, some of these guys will have some ‘splainin to do once their fee structure is disclosed starting in 2012.
December 12th, 2011 at 3:44 pm
moreland: This conversation is very timely for me. A regular Jane. Started with an independent CFP in 2006 and gave him $800K. 5 years later I still have $800K but he now has $40K (very diversified, moderate risk portolio) from his 1% fee. Given the market from 06-11, would he be considered average, above average, bad?”
This is what I mean. And how many planners actually “plan?” Now coming out even in this time period might well be considered a commendable performance if you put it in a certain context.
December 12th, 2011 at 6:14 pm
I had written up a list of questions to ask a prospective financial adviser: http://www.capitalismwithoutfailure.com/2011/04/lawyers-perspective-on-hiring-financial.html
It would be great to see what BR’s version would look like.
December 12th, 2011 at 10:01 pm
I’ll take a whack at it, but these questions don’t replace the advisor talking to the client about what his or her needs are. Its more like a cross-examination.
“What news sources do you consider to be the most reliable in terms of uncompromised reporting and analysis?”
First, and foremost, Bloomberg TV and radio. The first thing I do when my eyes open in the morning is take my Sony transistor radio with its earbud and start listening to “Surviellance.” During the day, I have one monitor tuned to Bloomberg TV. I scan dozens of websites, plus whatever catches my eye on my Twitter feed.
“Which economists and financial analysts do you read on a regular basis?”
I like the old crew from Louis Rukeyser’s “Wall Street Week,” believe it or not. They’ve been at this for years, they don’t need your money or your approval, but Birinyi, Holland, Biggs, et.al seem like straight guys- even if Biggs and Birinyi got a little scorched this year. I like BR for his straight talk, and for keeping things simple.
“Name at least 2 prominent economists whose judgment you consider to be compromised or faulty in some way.”
Nouriel drives me nuts. BR called him out months ago as the guy whose broken watch finally worked, and now we can’t get him to shut up. Other so-called “economists” working for AEI, Manhattan Institute, Brookings- all stupid mouthpieces for the agendas they’re paid to promote.
” What is the issue with their judgment?”
The play’s the thing.
“What lessons, if any, did you learn from the financial crisis?”
Never take anything for granted. That doesn’t express it as forcefully as it should, but I still cannot internalize how f&cked up things were allowed to get. Our financial managment class should live with nothing more than shame and regret for what they did. It’s like the World Trade Center collapse- I still cannot bear the sight of it.
“Is there anything that you are doing differently in terms of advice to clients or money management, since the financial crisis of 2009? ”
Actually, I had taken on more risk as we have retraced, but recently, have backed off or held the line a bit.
“What would you consider to be a very safe investment? Are there any risks associated with it? ”
I like old-fashioned Ginnie Mae CMOs. They pay monthly, they are the only other investment besides Treasuries backed by the Full Faith and Credit of the USG (provided we have any faith or any credit left) and while the timing isn’t right on them now, I would consider them for anyone looking for the most reliable income stream they can get with the greatest possible yield spread to a comparable Treasury- tough to beat, really.
“Do you think that housing will appreciate over the next 5 years? Why or why not? In real terms and in nominal terms.”
In my view “all real estate is local.” Barry and I both live on Long Island, and we both haven’t gotten singed, unless he bought in 2007 or something. Other areas will be wastelands for some time, like Central Florida, Nevada, etc. I do not see much in the way of price appreciation, and besides- making a prediction five years out is a bit much to ask of anyone.
“Are you willing to guarantee that a client will not lose money, in real terms, over any period of time – if that is the client’s only goal? ”
If the client wants that, I will present the product that fits that goal. Naturally, they will be unhappy with the return, so they will prod me for other ideas!
“Will you be willing to disclose all remuneration that you receive that is directly and indirectly related to working with me as a client? Are you willing to work solely for a fee and not on any commission basis?”
At this time, I work on commission only, and perhaps, in the future, I’ll submit an ADV and go RIA- I am already licensed to do so. I really do not understand the knee jerk reaction to commissions- believe me- I would have made more money parking these portfolios I manage for the skim, and calling myself a “wealth manager.”
“What do you think will happen with the US treasury market over the next few years?”
I see some downside in price (yield up) in the latter part of 2012, with the 10Y perhaps hitting the 2.50% mark. We’ve been down so long, it looks like up to us. Really. Truly.
“Do you believe in secular bull and bear markets in equities and interest rates/bonds? Why or why not?”
Surely they exist, as they are driven by sentiment- as is most of the market.
“For this question only, assume that you are 100% certain that the near future will bring high inflation. Given the world in which you find yourself today, what is the best place to put money?”
I wouldn’t be “100% certain” about any market’s direction, but if this were the scenario, stocks tend to be the best place to hedge against inflation, along with – hopefully again- real estate. I am not an investor in precious metals.
December 12th, 2011 at 11:01 pm
I think you may make the cut, flocktard. Would you like to be a CWF-Sanctioned FA?
I actually meant that I’d be interested in seeing BR’s questions – as in what he would ask. Of course I would also be interested in BR’s answers.
December 13th, 2011 at 12:08 am
Moreland01, use ETFs or index funds (e.g. Vanguard) and keep your fees and expenses to a minimum. Set a target asset allocation and adjust as you get older. Rebalance once a year. Below is David Swensen’s basic consumer portfolio. If you are older I would lighten up on equities and real estate and add to bond allocations.
Total Stock Mkt 30%
Intl Developed Mkt 15%
Emerging Markets 5%
Real Estate 20%
US Treasury Bonds 15%
TIPS 15%
December 13th, 2011 at 9:07 am
@ Matt
The problem with this portfolio is that it is long only, way too correlated, and it provides ZERO protection against Lehman like events. It is typical of the dumbed down nonsense offered to the retail client- and of course, they pay the price. TIPS are a joke, and have been for years.
“Diversification is no substitute for market knowledge.”
December 13th, 2011 at 9:28 am
@ Flocktard, “market knowledge” is the big elusive elephant. Nobody can see the future yet they all try to predict it based on past results. Then they finish by saying that past results are no indication of future results. And now their historical trends data is muddled by international politics which absolutely nobody can predict.
I’m in my late 40s. I need to get back in the market. There are just too many unknowns. Too much incivility amongst the rule makers. Too much corruption. Too little consequences for the corrupt. The market is rigged. And this thread has not helped me choose a direction, unfortunately.
I’d bet that I’m not the only one who feels this way.
December 13th, 2011 at 10:44 am
@flocktard that portfolio was developed for the long term investor by David Swensen (Yale CIO). I guess he doesn’t know much about investing. Nor do Warren Buffet, Jack Meyer (former Harvard CIO), Jack Bogle, and virtually the entire academic literature. The whole point of this type of investing is it minimizes payments to dudes like you. If you could actually provide alpha you wouldn’t need client money would you (to be fair, after you became established enough to have some decent savings).
Warren Buffett: “Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”
Jack Meyer, head of Harvard University’s endowment fund: “The investment business is a giant scam. Most people think they can find fund managers who can outperform, but most people are wrong. You should simply hold index funds. No doubt about it.”
Moreland01, the investment “game” has always been rigged and we go through periods like 2007-2009. We just haven’t really had a severe one since the early 70s. Stick it out for the long run and ratchet up your bond allocations if you can’t stomach big turns as well. Your results will suffer but you will sleep better.
December 13th, 2011 at 3:03 pm
From Mr. Swensen’s Wiki page:
“After Harvard’s endowment dropped a record 30% to $26 billion in the year ended June 2009, an 81 page report released in May 2010 found that “The endowment model (which Mr. Swensen invented) of investing is broken. Whatever long-term gains it may have produced for colleges and universities in the past must now be weighed more fully against its costs — to campuses, to communities and to the wider financial system that has come under such severe stress.”
Ratcheting up bond allocations is PRECISELY what I do. All the models you mentioned, including from that living fossil Jack Bogle, are now DOA. I do not know why people think they can just wait for the proverbial “decent interval” and things will go back to the way they were. They’re not. You are in a new reality.
I would have liked the United States of the post war era to last for the rest of my own life, too. But it’s gone, folks.
I used to roll over LEAPS in stocks like General Electric for years and laugh my ass off. But we’re not going to be laughing for a long, long time.
For the investor, for myself, and for my children, no one is sorrier than I.