This op-ed was submitted by Audie Apple, co-founder of GuardVest, a service aimed at informing investors and holding advisors accountable.
Have I got a deal for you...
Oscar Wilde once quipped that "nowadays people know the price of everything and the value of nothing." As clever as that seems, it certainly doesn't apply when the subject is investment advice. In fact, investment advice is the only thing I can think of in which the buyers don't actually know what they pay. How could they? Has your portfolio manager or investment advisor ever sent you a bill? Of course not -- they have access to your money already and just help themselves. Consider a recent study in which investors working with investment advisors were asked what type of fees their advisors charged -- not even how much they were paying. Only 40% of respondents were even willing to guess!
Furthermore, the explosion in variety and complexity of investment products obfuscates the issue to the point that even investment advisors themselves are often confused about the fees their own clients pay. In another recent study, 63% of advisors underestimated the fees they charged their own clients -- on average by 20%.
At this point, investors should ask themselves, "If I don't know what I am paying in total expenses, what are the chances that when I find out I am going to be pleasantly surprised?" Not good.
To shed some light on the subject, a 2011 study by PriceMetrix covering 15,000 advisors and 1 million fee-based accounts found that the average advisory fee charged on accounts between $250,000 and $500,000 was 1.47%. Note -- this is before considering embedded investment product expenses such as mutual fund expense ratios, which can often add another 1% to the advisory fee.
If that isn't alarming enough, the dispersion of fees across advisors and accounts is startling. The PriceMetrix research found that of 100 investors with accounts valued between $250,000 and $500,000, 11 were paying less than 0.75% while 15 were paying more than 2%! For a $100,000 investment over 20 years, that extra 1.25% in expenses will cost the investor $59,000 -- more than half his or her invested capital.
One of the "framing" tricks financial firms use to make alarmingly high expenses look reasonable is to express them as a percentage of the invested capital. But really, investors should think of these fees in the context of their likely return on investment -- a framework that casts a very different light on the subject. After all, the investor puts up all the capital, assumes all the risk, and shares the rewards with the advisor. If the returns are low or even negative, the advisor still gets paid. What a deal!
As unappealing as that sounds, today's reality is even worse. From 1980-2007, a typical portfolio of 60% U.S. stocks and 40% bonds would have returned about 8.4% before expenses. A quick survey of the published research of the largest providers of investment advice to retail investors produces a return forecast for a similar portfolio of 5.6%. Normally, when you get less of something, you pay less. Not so with investment advice. Fee schedules haven't changed. So let's do the math and look at expenses as a percentage of expected investment returns over 10 years.
Using industry data that suggest 2.43% as the "all in" investment expenses including advisory fees and investment product expenses, the 8.4% market return produces a nearly 6% net return to the investor. Of the $124 in earnings an initial investment of $100 would produce over 10 years, $45 would be consumed by expenses -- 37% of the pre-fee return.
Now do the math based on a reduced return forecast. To be generous, this analysis uses a pre-fee return of 6%. Now fees consume 47% of the expected return. If that isn't disheartening enough, the net return on the invested capital to the investor is only $42 -- down by over half from the $86 returned to the investor in the past.
Just to restore the proportionate split of returns from the past would require that investment expenses be reduced by 25%. And certainly there is room for debate on whether that is a reasonable split of the return on investments between Wall Street and its clients.
When you stop and think about it, this is the deal Wall Street is offering investors today:
You put up all the capital. You take all the risk. We will split the earnings 50/50. And by the way, if returns are lower or even negative, you still need to pay me for my time.
If the offer were framed in that way, I think most investors would be insulted. But with clever complexity and opaqueness, Wall Street keeps investors in the dark about how much they are really paying and it is business as usual.
It is time for investors to demand a better deal. Waiting on the invisible hand of market forces to naturally deliver this outcome will not work when the buyer of the product doesn't have all the facts and information necessary to hold his or her advisors accountable. Particularly while the industry continues to resist calls to be viewed as fiduciaries and be required to always place client interests first. Are you sure you know what your total investment expenses are? Don't you owe it to yourself to find out?
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