What's the Real Cost of a Financial Advisor
Working with a Financial Advisor
One of the most important considerations is the type of wealth advisor you choose. There are 2 main types. The first charges a percentage of Assets under Management (AUM), the second, charges an hourly fee.
Many people look at the fee structures in the wrong way. Let’s look at an individual with $20M in dividend producing stocks. Assume a 2% yield which is $400K pretax. At a blended rate of 20%, that’s $320K net after tax. If you pay an advisor 50 basis points (1/2%), your annual income drops from $320K to $240K. The calculation for that is as follows.
The 50 basis point fee reduces for net income by 25%. That’s a significant reduction. Some investors might look at it differently. They expect a 10%/year return on their equity holdings and dismiss the 50 basis points as a cost of doing business. The advisor fee is deducted directly form your account. Similar to the IRS withholding payroll taxes. If the advisor had to send you a bill at the end of the year and you had to write a check for their fee, people might feel differently about the ½ to 1 percent the typical advisor charges.
It’s important to have access to intelligent, experienced, rational people to discuss your investment objectives and your investment options. If you don’t have friends and/or family who fit this role, then a financial advisor is a good option. We recommend an hourly fee-based advisor. Assume you pay $500/hour and you meet quarterly for 2 hour blocks, that’s a total of 8 hours a year. You can cover a lot of ground in 8 hours. Your cost would be $4K vs $100K. Vanguard also offers a dedicated advisor at the rate of $8,750/annually for a $20M account (according to their website). That’s quite a savings over $100K/annually for an advisor who charges ½ percent.
A good financial advisor can help you in several important areas.
1 – Refining your goals: for example, my goals are to provide for my grandkids, their kids and their kids’ education. The plan should include how many grandkids, when will they start school, which states will the private schools be in, is grad school included?
2 – One you’ve got the details nailed down, it’s time to put costs to them. Then calculate how much you need in today’s dollars to pay for them. This calculation needs some assumptions. What’s your expected rate of return? What’s the expected inflation rate for each area of education (lower school, college, etc)? What’s the expected tax rate?
There are other steps which we’ll discuss in another article titled “Are you rich enough”.
When you’re hiring an investment advisor, you want someone who can understand not only your goals, but your temperament. If you’re very risk adverse and aren’t able to sit tight and watch your portfolio drop by 30%+ in a downturn, you shouldn’t be heavily weighted to equities. In our opinion, this is the biggest mistake investors make. When the market has gone up for several years, some investors ignore the potential for a large drop in the market. They think they’ll be able to follow the advice of Warren Buffet and just ride out the drop. When their net worth drops from $10M to $7M with no end in sight, the decide $7M is better than $5M and sell out of their equities. Select an advisor who can help you build a portfolio that you’ll be comfortable sticking with during market break.
Remember, you’re hiring an advisor to help you match your risk to your goals, not to outperform the market. Every study I’ve read shows a very small percentage of mutual funds outperform the market over a 10 year period. According to the American Enterprise Institute (AEI) it’s about 10%. That means your odds are 9 to 1 that you’ll underperform the market by choosing an active fund over an index fund. You don’t need to pay an advisor $100K/year to pick an index fund or work on a budget for how much money you need to meet your goals. An accountant will do just as well, if not better.
It’s also very unlikely that a financial advisor will outperform the index by picking individual stocks. If they could consistently outperform the market by 2% or more, they’d be running a mutual fund or hedge fund.
