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The Invisible and Brutal Cost of Using a Financial Advisor

How much could you really save by being your own financial advisor?

Hidden fees are almost synonymous with the financial world, particularly financial advisors. Millions of ordinary investors feel the subtle sting of a mutual fund's egregious "sales load" or the painful pinch of the infamous 12B-1 fee.

But the cost I'm talking about is even more hidden. You probably have no idea you are paying it. You'll never see it in a prospectus.

In fact, it's invisible.

One of the most common fees financial advisors charge their clients is the 1% annual fee, based on assets of under management. Every quarter, 0.25% is deducted from the client's account and slipped in the pocket of the financial advisor's firm. Even though this katana-like fee structure should be overhauled, this is not the cost I'm talking about -- though it's related.

I'm talking about the future investment opportunity you lose every time that financial advisor deducts from your account each quarter.

Real-life example
Let's walk through that scenario but put some names and numbers to it.

Laura is a 34-year-old orthodontist. She recently finished paying off her student loans and is approached by a financial advisor who's graciously willing to manage her $500,000 investment account for a 1% fee per year. Laura paid over 5% interest on her student loans, "Only 1% per year?!" she says, "Sign me up!"

Over the next 10 years, let's assume the market (and Laura's portfolio) achieves an inflation-adjusted annualized return of 7% (or 1.71% per quarter).

After 10 years, the value of Laura's portfolio sits at $892,000.

Over that time period, Laura paid her advisor $68,290. Even an orthodontist would think that's a pretty-penny to charge for a service.

But at least Laura can clearly see that money being withdrawn from her account every quarter. However, as those quarterly payments flowed out of her account and to the advisor, she is sacrificing all future growth on that forgone money.

Laura's first quarterly payment to her advisor would have been around $1,271. Had she retained that money in her account for the 10 years, it would be worth $2,459 -- nearly double its original value. After 10 years of lost opportunity, that first quarterly fee was actually closer to 0.5% (or 2% annually).

Altogether, over the account's 10 year history, Laura would be giving up an extra $25,421 in missed returns. Coupled with the actual fees paid, Laura is out nearly $94,000 -- $89,000 more than had she put her $500,000 into a Vanguard S&P 500 index that charges 0.05% annually.

Assumed: 0.25% quarterly advisor-fee and 0.0125% Vanguard quarterly fee. Assumed: 1.71% quarterly returns. Assumed: $500,000 starting balance.

Let me make one thing clear. I am not saying financial advisors are wicked people nor am I saying many advisors don't provide a deeply valuable service. However, if you do use a financial advisor or money manager, take a long, hard look at the graphs above and ask yourself, "Am I getting my money's worth?"

If the answer is a clear "No," do something about it. Relatives, neighbors, and especially your financial advisor will tell you that "You're making a mistake" or "Investing is too complex for you to understand."

Start by putting your own numbers on the page, like Laura.

But don't delay because with every passing quarter, you're losing money whether you see it or not.

Start your portfolio today
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Read/Post Comments (12) | Recommend This Article (47)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 02, 2014, at 1:44 AM, anuragupta wrote:

    This article implies that all the advice by financial advisor to Laura is worthless. All Laura should have done is invest with vanguard funds.

    A good financial advisor helps the client figure out her financial goals over time taking into account her present and future cash flows, current savings and liabilities and risk tolerance. For those who are not financially savvy or do not have the time to study investing, a trusted financial advisor is well worth his fee. The article should analyze what people like Laura would do without financial advisors. There are so many out there who either make bad (risky) investments and lose money or don't invest at all.

    And finally, don't mutual finds from TMF not charge a management fee? Even TMF newsletters cost money and the most premier services are worth no less than the much reviled financial advisor, percent wise for a portfolio like Laura's. Why should investment advice or services be free?

    Anurag

  • Report this Comment On June 02, 2014, at 3:04 AM, DUMMYDOC wrote:

    Hey Anurag,

    I can easily put myself in the "orthodontists Shoes" happened to me.

    Got lousy returns and only thing guaranteed was the fee to the managers!

    Count me out!

    Everybody has a right to charge a professional fee. But! Nobody should get a percentage of what you are worth! WRONG!

  • Report this Comment On June 02, 2014, at 9:28 AM, daveandrae wrote:

    And what about the invisible and brutal costs of individual investors NOT using a financial advisor?

    When are you going to write an article about that?

  • Report this Comment On June 02, 2014, at 9:59 AM, FAHenry wrote:

    Dear TMF and it's readers, first, you start off this article with a complete misrepresentation of one of the most highly regulated industries on the earth. Every client who is in any fee-based program I know of has not only had full disclosure by the financial advisor upon opening such an account, but signs an application with the fees written or typed onto the signature page thus acknowledging that they understand the fees. These fees are talked about and even negotiated between the advisor and the client. So anyone who is in a fee-based account and stated that they didn't know it was either lied to by the representative, didn't pay attention upon opening the account or may have dementia. Whether or not someone believes they are getting their money's worth will be figured out over time. From my experience most customers truly like and have confidence in their advisors and have over a 10 year tenure with their advisor.

  • Report this Comment On June 02, 2014, at 10:31 AM, mcampbell8 wrote:

    David,

    Thanks for pointing out the real impact of using a financial advisor. I understand that you are not advocating that people stop using advisors and their wealth of knowledge. As with anything, there is a price to be paid for the service. And it exceeds the fee and includes future earnings on that fee as well. But as you pointed out, each investor will have to make that decision and your article provided better focus on the real costs. If someone isn't really making money with an advisor, they are clearly losing in the long term. Whatever route they go, they need to ensure it is a winning one for their portfolio.

  • Report this Comment On June 02, 2014, at 11:05 AM, Jameson477 wrote:

    FAHenry,

    I think you missed the point of the article. While I agree that anyone using the services of a FA is responsible for being aware of the fees and that the full disclosure helps ensure the customer to be, the author's point regarding the opportunity cost of those fees is likely not disclosed as it is not a fee. There is nothing to disclose, but obviously if one uses his 1% to buy coffee (or pay a FA) that is 1% less that is growing. This isn't to say that the FA profession is not needed/valued, there definitely is something to the idea of trusting the input of experts... Especially when they consistently beat the market. I go my own way as I value Warren Buffet's ideas on index investing for the majority of my investments, but to each his own...

  • Report this Comment On June 02, 2014, at 11:32 AM, bladerunner wrote:

    While I can understand this point of view and the article does represent one aspect of costs associated with professional guidance, it fails to recognize the underlying and initial reasons why one typically works with an FA. The main reason why most individuals work with an FA or a wealth manager is based on service, not return. Typically, the agenda of an individual seeking advice from an FA is based on professional services including comprehensive wealth planning, risk management, portfolio management, business succession, estate planning, concierge services, and tax planning in addition to building a relationship with the same person/team. Vanguard offers the same 1-800 number. An investor buying this service (Motley Fool), which isn't cheap, comes for one thing and one thing only- return. To the person's comment above, I believe its unfair and inflammatory to suggest that any fee based models costs are invisible to the client, because they are not. (You are insinuating an inappropriate conclusion to the costs of professional management). Your mutual fund charges the same fees and you get paid more when the value goes up; sounds familiar. The article also fails to recognize the time, patience and emotional management that goes into working with a client which is an intangible service that is nearly impossible to assess and assign a value to. A person who has the time to manage their own assets and would like to do it themselves generally will not work with an FA because they probably wouldn't get the value they are looking for, which is what E trade and Schwab... are for. (There is an old statistic that when one's account value reaches $600,000.00 at Vanguard they typically seek professional advice).

    Also, a majority of people out there are generally under-educated and avoid investing all together because of their lack of understanding, which this article also fails to recognize as well. This is another benefit of an FA and another part to the cost of professional services. In closing, I really do like this website and it offers valuable services however is deters me from wanting to continue using and paying (RuleBreakers) for these services when I see inflammatory articles such as the above, particularly one that lacks critical points as to why one uses an FA versus someone who does not.

  • Report this Comment On June 02, 2014, at 2:22 PM, jpacheco2 wrote:

    Great article as most people do not know or realize the real cost associated with FA.

    To bladerunner - in it's simplest form a FA has a duty/job and objective to make his/her clients money and look out for their client's best interest ahead of their own. If I lose money because my FA lost me 25% last year yet he/she is entitled to 1% of value?

    What I just stated above is the definition of a fiduciary which most FA's are not! In fact IMO one shouldn't be a FA without first being a certified fiduciary (would alleviate their ability to pretend they weren't aware of their responsibilities to their client/s).

    If you're looking for a FA in my opinion you'd be crazy not to ensure that they are fiduciaries as they have a legal obligation to look out for their clients best interest. However, that's not without risk as well. If you need someone to manage your money, find a fiduciary if you can't find one you trust, manage it yourself everything else is gambling. I'd rather bet on myself than anyone else and I can live with if I lose everything but I worked for it all in the first place.

    Ask yourself these questions:

    Who are you betting on?

    How well do you really know/trust them?

  • Report this Comment On June 02, 2014, at 6:07 PM, DaveShore wrote:

    Yes, and Pat Riley probably wasn't worth as much as they paid him when he coached the LA Lakers to all those championships. Those guys had so much talent they probably would have won lots of games coaching themselves.

    This is, of course, a ridiculous position. If a client works with a salesman who is paid by a brokerage or fund company, look out.

    If you pay a fiduciary advisor who works in your interest, who keeps you out of trouble, who helps to manage your emotions (greed AND fear) and who keeps you in low cost, tax effective strategies, how do you know you're not better off, even net of fees?

  • Report this Comment On June 03, 2014, at 8:26 AM, bocaadvisor wrote:

    There is nothing deeply 'hidden'. All major broker-dealers require their advisors to disclose their own fee schedules to their clients (if a fee based advisor) 1. It's on account level contract) and 2. the fee's show on the client's statements. In fact 3. FINRA/ SEC reg's REQUIRE reps to provide at least one annual review each year with clients' to review their fee's, risk tolerance, strategy and results and to PUT IT IN WRITTING.

    Just like any profession, you get what you pay for, ....so I do agree that clients SHOULD understand and be comfortable with the results and service of their rep or move on.

    Still -the COST of doing it yourself- can be catastrophic to your nest egg and retirement.

    Dalbar studies indicate that the majority of investors underperform the US market by over 70% year-after-year- and barely beat inflation. Bottom line, don't straighten your own teeth and don't manage your own money if you are not well-versed in either field. At www.ulinwealth.com. we suggest to Hire an accredited pro.

  • Report this Comment On June 03, 2014, at 8:54 PM, JimPi314 wrote:

    I had an FA who provided no services such as "comprehensive wealth planning, risk management, portfolio management, business succession, estate planning, concierge services, and tax planning". The only comprehensive wealth planning he provided was trying to talk us into investing more money with him, and transferring all of our accounts to his company - in other words, planning for his own wealth. I'm sure there are good FA's out there but this guy charged a lot for not very much and lost us money. One thing he did was trade a lot - his 'tax efficient' account had trades of 8x the balance of the account one year. Who paid the short term capital gains tax on that? He said it was his ethical duty to take it out of his fee. Ha Ha, no he didn't, I wanted to see if you were paying attention! Oh yeah, and when his company didn't report the basis cost on these transactions, who got audited? Me! Oh, these things happen, he said. So a few months later when we pulled the plug on this clown, that's what was on my mind.

  • Report this Comment On June 11, 2014, at 5:34 PM, rmlesan wrote:

    Perhaps I can offer some useful perspective. The biggest issue as I see it isn't the transparency of fees (but yes, there is room for improvement here), it's the lack of accountability across the profession for any value proposition on the part of "financial advisors." And that's the fault of the industry, the regulators, and even investors themselves, although I'll give a pass to that last group since they are the least capable of the three at defining and measuring one's value proposition.

    Yes, there is a considerable opportunity cost when paying advisory fees. But there can also be considerable opportunity cost to not paying advisory fees if it means your decisions will lose you more money than if you'd paid those fees and made better decisions. But figuring out which is which is so rarely done with any rigor or deep thought that we make no progress on this conundrum.

    The reality is that in this day and age of (albeit difficult to come by sometimes) transparency, low-fee options, and nearly universal access to all worthwhile investment strategies and structures, we can finally force a proper discussion on this issue. My own contribution is this: require that a money manager explain his/her past performance and decisions relative to an appropriate benchmark, after fees. S/he may not beat the benchmark, but that's okay. S/he should be able to get close, and any disparity can perhaps be explained as worth the cost because of all those other "non-performance-related" areas of value-add they offer with the relationship such as time and effort saved, peace of mind, comprehensive wealth planning, estate planning, tax planning, concierge, etc. If the gap is large, they better be offering a ton of "other" value and if not, they should be fired. But consider the performance numbers in the proper context - across cycles and over a long enough period of time to be relevant.

    Frankly, I strongly believe that those areas of additional value-add other than time/effort saved and peace of mind are useless since they should have a lawyer doing the estate work, an accountant doing the tax work, and forget about "concierge" (this is a totally b.s. piece of the profession that it should be embarrassed about). So, the value an advisor offers really does just come down to what they could do for your portfolio above and beyond what one could do were they to simply invest in a couple stock and bond index funds. It's no more cosmic than that.

    If folks looked at things that way, I think they'd quickly find that the vast majority of "advisors" are NOT worth what they are paid. They aren't worth much because they don't really know much in terms of portfolio management. The ugly secret in the industry is that there are absolutely zero requirements that financial advisors actually know anything about managing portfolios! Even CFPs have very little portfolio management background. CFA charterholders do, but they are few and far between in the advisor community. Most folks in this industry are self-taught via on the job training. That training lacks any rigor and simply amounts to time in service rather than a true, measured, introspective form of training that we would expect in a real profession. The other dirty little secret is that practically every industry designation is nothing more than a simple little self-study exercise that could be done in a weekend (the only ones worth a darn are CFA for money management, CFP for planning, and CPA for tax; obviously you need a law degree for trust and estate work).

    So, while I myself am a portfolio manager with a CFA charter, I do believe that most are better off managing their own portfolios rather than paying the fees most firms charge. And remember, that's before they outsource your portfolio to various mutual fund companies, etc. (yes, they are the epitome of a middle-man).

    So in the end, do think long and hard about that decision to hire another to manage your portfolio. Require that they prove their value through the work they've done for others and do not fall for that awful justification that they provide value beyond portfolio management because 1) they don't, and 2) you don't need that from them. There is value and peace of mind in not having to do it yourself but it's certainly not worth what they charge and you find that you still worry when things hit the fan.

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David Hanson
TMFHurricane

David has been with The Motley Fool since 2013. He is a graduate of the University of Miami. Follow David on Twitter for all things finance, marketing, and investing.

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