"Where Are the Customers' Yachts?"

How fees destroy investor returns.

Feb 21, 2014 at 11:20AM

Over Christmas, a family friend asked me to take a look at her finances. She's in her 60s, worked hard her whole life, and accumulated a couple of million dollars to retire on.

She's had a financial adviser at one of the nation's largest banks for the past five years. I met him once; he's a nice guy. Smart, able, honest, and competent, he put my friend in a basket of investments -- mostly low-cost index funds, a few individual stocks, and a portfolio of bonds -- keeping her on track to enjoy a comfortable retirement.

She's happy with her adviser. For the most part, I was, too.

There's just one problem: He charges an incredible 1.5% of assets as his annual fee.

I tried to explain to my friend how high this was, but my comments were met with a shoulder shrug. One and a half percent didn't sound like much to her. 

But when we added up how much she was paying her adviser every year, it was literally the single largest line item on her budget. More than her mortgage, more than her food bill, more than she spent on travel, clothes, entertainment, gifts, medical care, cars, and tuition for her kids.

That got her attention. So did this: In the past five years, my friend has spoken to her financial adviser seven times. When you break down how much she's paid him, we figured each meeting cost her $21,000, or nearly $50,000 per hour.

Fifty thousand dollars per hour. To pick a group of index funds and mutual funds.

This is not a made-up figure. It is how traditional wealth advisers operate.

Six decades ago, Fred Schwed wrote a book called Where Are the Customers' Yachts? The title came from a story about a visitor in New York more than a century ago. After admiring yachts Wall Street bought with money earned giving financial advice to customers, he wondered where the customers' yachts were. Of course, there were none. There is far more money in providing financial advice than there is in receiving financial advice.

The title is as relevant today as it was back then. There are few industries that pay themselves so much for doing so little as financial services.

But the industry is changing. I believe that within the next five years, stories like my friend's will no longer exist. The Internet has lifted the veil financial advisers hid behind, and technology has allowed new ways to deliver financial advice more efficiently than ever before. Today, Americans have options to obtain top-notch financial planning and investing advice at a fraction of the cost charged by traditional Wall Street banks. More on that in a moment.

First, more on those fees.

Morgan Stanley's financial advisory division brought in $14 billion of revenue last year. Bank of America Merrill Lynch pulled in $17.7 billion. JPMorgan Chase took in $11.2 billion. If those three banks were their own company, the revenue generated by the stockbrokers and financial advisers alone would be the 53rd-largest company in the S&P 500, just behind Coca-Cola, and ahead of Disney. A lot of these advisers are competent and honest people. But do their services match the fees they charge? Hardly. And that's not even a controversial statement inside banks: According to a survey by the U.K.'s Chartered Institute of Personnel and Development, three-quarters of employees at financial firms think their colleagues are paid "excessively."

A financial adviser might be worth a generous fee if he or she were able to consistently outperform a benchmark. But most can't come within hailing distance of doing so. According to a study by consultants at IBM, global financial advisers overcharge their clients by $250 billion a year for services that fail to meet their stated benchmarks. That's more than the federal government will spend this year on interest payments for our $16 trillion national debt. 

And this doesn't even include additional fees charged on investment products recommended by your adviser. Say your financial adviser charges you 1.5% of assets, as my friend's did. Now say the adviser recommends a mutual fund that itself charges a 1% management fee. Add the two together, and suddenly you're paying 2.5% of your assets in fees. For context, over the past century, the stock market has generated an average annual return of 6.5% after inflation. In this fairly optimistic scenario, nearly 40% of the profit generated by your nest egg will go straight into the pockets of your advisers -- nearly half the upside for them, and all of the downside risk for you. During a sluggish period like the one during which stocks suffered from 2000 to 2010, virtually every dime of income that your assets generated was likely eaten up by fees. And remember that bonds and other fixed-income products typically yield less than 3% these days, causing advisory fees to eat up an even larger portion of returns.

Financial Adviser Annual Fee


Mutual Fund Adviser Annual Fee


Total Adviser Fees


Fees as a Percentage of 7% Annual Returns


Fees as a Percentage of 5% Annual Returns


Potential Fees Paid on $2 Million Account over 10 Years, Assuming 7% Annual Returns*


*Includes opportunity cost of forgone investment returns on fees paid.

Before long, we're talking about fees that would make a loan shark blush. When all management fees were added together in my friend's account, she was paying nearly twice as much money to Wall Street advisers each year as she was paying for her mortgage. Where are the customers' yachts, indeed.

I believe people who work hard and provide a valuable service should be paid handsomely. But financial advisers as a group abuse the concept of meritocracy, often providing mediocre talent for rock-star fees. They can get away with it because their clients, like my friend, often can't grasp the context of how much they are being charged.

If you're worried about your own money, try this: Add up all the fees you're paying to people who manage your money. That includes everyone from your financial planner to your stockbroker to the managers of the mutual funds you invest in.

Are you paying more than 1% of your assets in fees?

Then you may be paying too much.

The good news is that the industry is changing fast. In the old financial system, brokers and financial advisers acted as gatekeepers and tollbooth takers. In the new one, technology, automation, and low costs are taking the industry by storm. It's similar to the changes that took place in the travel industry over the last two decades. For years, travel agents made a fortune because if you wanted good travel information, they were the only ones who had it. Then the Internet turned that model upside-down, bringing the cost of quality travel advice and the ability to book a trip down to near zero. 

Contact Morgan Housel at mhousel@fool.com The Motley Fool has a disclosure policy.

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