Fees

Tyler LinstenInvesting

Fees are finally a hot-button issue in the financial world. As they should be! For too long, fees were ignored and accepted as just the “cost of doing business” with an investment advisor, or worse, with a broker, an insurance “guy” or the CPA down the street selling mutual funds.  Thankfully, it’s now becoming painfully obvious to many investors that high fees are, without a shred of doubt, cancerous to investment returns and the individual investor.

Ask yourself: How can any self-respecting advisor feel good about being an advocate for low fees on investment funds, but on the other hand charge clients the highest amount they can get away with?

I started this advisory with a low-fee structure. I was laughed at by numerous consultants and industry “experts” for charging half of what was considered the Gold Standard 1% rate. Now I’m doubling down on the idea that I should win only when clients win – and also on the Amazon.com philosophy of being relentless in finding ways to charge clients the least amount viable instead of the most.

An Update

Instead of a plain 0.50% per year fee on assets under advisement, broken up quarterly with no ceiling, I’m now setting a cap on the quarterly fee at $900. This results in a maximum yearly fee for clients at $3,600 per year. It ends up looking a whole lot like a $300 per month subscription for clients at or above $720,000 in assets under advisement, and that’s by design. Clients with larger portfolios shouldn’t subsidize clients with smaller portfolios.

Also, I now have a minimum fee of $297 per quarter. This number is no mistake and settled there for a reason: it’s intended to replicate a $99 per month charge. A big problem for clients is when they have no (or low) assets it’s hard to get help because advisors don’t see the value if they can’t draw from a large portfolio. My thought is that most people, regardless of account size, can manage to pay the equivalent of $99 per month if they’re serious about getting investment advice. I don’t ever want to turn someone away because they don’t have a large portfolio.

Many advisors are adopting either (1) a monthly subscription model with a large upfront fee for all clients or (2) a flat yearly fee model. Both options give the advisor zero financial incentive to grow client portfolios at any asset level (besides to keep clients just happy enough to not fire them).

For instance, one advisor is gaining publicity with a $4500 yearly fee per relationship. While a flat fee across the board is much better than many of the alternatives, I personally don’t want to be incentivized to only get clients to “sign on the bottom line” — I also want to win when they win, and share in the loss if account values go down — because I believe in the notion that financial incentives are important. This subtle, but important update to my fee model confirms my commitment to help turn smaller portfolios into larger portfolios.

Here’s an interactive chart to show the different estimates of yearly fees based on the models I’ve mentioned:

As you can see above, it is a very painful situation to hire a flat-fee advisor as a client with little or no assets, just as it’s VERY expensive to hire an advisor who charges 1% with no ceiling as a client with a large portfolio.

It would give me a hefty amount of personal satisfaction to again be lambasted for “leaving too much money on the table” by charging clients as little as possible. This is a bit of a twisted sounding dream, true, but would be an absolute confirmation of my desire to take the Amazon.com approach to heart.

Channeling the spirit of Samuel L Jackson’s character in “Pulp Fiction,” I challenge the so-called experts once more:

SAY “YOUR FEES ARE TOO LOW” AGAIN. I DARE YOU…I DOUBLE DARE YOU, (redacted)!

Bring it on, “experts.”

 

Why Hire an Advisor? It’s a No-Brainer

Tyler LinstenInvesting, Personal Finance

 

Yes, I happen to be an investment advisor myself but I’ll try to prove to you this is not some self-serving advertisement with links to SIGN UP FOR MY SEMINAR! I see it as a no-BS manifesto for the power of low fees and simple advice. The added value of being an investor with a trusted, reasonably-priced partner in your corner tends to far outweigh the monetary cost of the relationship. It may even be more important now than ever if we consider the outlook for returns in the medium-term. All scenarios below are *hypothetical* and all numbers are *estimates*.

Givens: You need to save money for the future. You need that money to grow faster than inflation if you hope to stick with a reasonable savings rate over your lifespan and still retire comfortably. To get that return above inflation (the “real” rate) you’ll have to be committed to being a long-term investor. I’m going to put this into a simple equation:

Your real returns =

what the market returns

subtract inflation

subtract your errors

subtract fees

subtract taxes

Put another way:

Returns above the rate the bank pays you (today: zero) =

how well global stock and bond markets perform

subtract the gains eaten by the cost of living going up

subtract the things you do to screw up like trading too much, not being allocated properly, or trying to time the market

subtract the costs of your investments and advice

subtract what you have to pay to the government

Visually:

=  –  –  – – 

 

Notice there are a lot of things that subtract from your returns, but none that add to it besides the return from markets? Now you see what I’m getting at and why I’m saying it pays to get someone in your corner. Let’s break it down into things you can and can’t control.

Things you can control: your errors, fees and minimizing taxes.

Things you can’t control: what the market returns, inflation and tax rates.

Your focus should strictly be on eliminating the errors you make, minimizing fees you pay on your investments and for advice, and how to invest as much as possible in tax-deferred or tax-free accounts. No matter how much investors – professional or otherwise – try to fight it, there’s a ton of important stuff out of our control.

Why is it even more important today?

Since we know that valuations around the world are currently elevated, the end of a decades-long bond bull market may be near and global economic growth is estimated to remain slow for some time, it’s more important than ever to maximize our returns because investors may no longer have a strong tailwind of low valuation, low interest rates and strong GDP growth. You can also read “maximize our returns” as “minimize mistakes and wasteful expenses.”

Let’s say a globally diversified stock/bond portfolio of low-cost index funds is expected to return 5% after minimal fund fees per year going forward, compared to a more lofty return of something like 8% as we’ve seen in the past. We must try to get every bit of that 5% as possible because we know that inflation, fees, and taxes are going to dissolve some of that 5% no matter what. In order to harness the power of compound interest, it’s crucial this return is not chipped away any further.

An “average” investor, one with roughly normal intelligence and investing knowledge, may try to get that five percent without help from an advisor – “cut out the fee and do it myself!” Smart, right? Well, not really. We know that the average investor hurts their own returns – those errors we were talking about earlier – to the tune of roughly 2% per year. It’s easier than ever to do something damaging as an investor because there are so many shiny new tools, products, and gimmicks available at the download of an app. The phenomenon of sabotaging our own returns is known as the behavior gap. It’s the difference between what the market returns and what an investor gets after adjusting for doing return-damaging things.

Estimates of the behavior gap. Photo courtesy of @investerasmart on Twitter.

Estimates of the behavior gap. Photo courtesy of @investerasmart on Twitter.

So now a do-it-yourselfer who started with an easy 5% has acted like an average investor and sabotaged their returns and paid a penalty of losing 2% from the 5% they could have had with almost no effort. Now they’re left with a 3% return. But what about the cost of their investment? If they chose active investments – read: expensive – then we can assume the fees they paid on their investments could be around 1% more than passive index funds. Now our investor has a 2% return. I’m also being generous and not calculating the effect that active investments are proven to perform worse than passive investments.

What about inflation? Well, inflation has been averaging about 2% per year and is expected to remain low for quite some time as the economy deals with the potential reality of lower global growth.

Our investor, after seeing a diversified portfolio of stocks and bonds return 5%, is now left with exactly ZERO gain in purchasing power for his/her efforts at investing. His/her behavior combined with high fees and inflation has left them no better than a year ago.

So why utilize an advisor? Simple: eliminate the behavior gap and ensure fees and taxes are minimized wherever possible. Instead of a portfolio of active funds, a wise advisor will recommend inexpensive index funds – bringing those fees down from the estimated 1% to around .20% (if not lower). Next, the behavior gap can be reduced, if not eliminated altogether and would add an expected 2% return to an investor’s portfolio each year that would otherwise be hurt by an average investor’s behavior.

Lower fund expenses: estimated savings of 0.8% per year

Eliminate the behavior gap: estimated 2.0% return added

Cost of (this) advisor: .5% per year

Net gain from working with advisor in this hypothetical scenario: 2.3% per year

Conclusion: an average investor, who hurts his/her own returns with detrimental behavior and expensive/underperforming funds may very well be in dire need of professional help (especially) if returns are to be lower than average for an extended period of time. The tailwind of high stock/bond returns will no longer be able to mask these inefficiencies, putting the average investor in a very tough spot. Saving for retirement with a low-to-zero real return will be a tough task to accomplish if an investor decides to go it alone.

Even shorter conclusion: keep fees low, hire somebody to stand between you and bad decisions. 

 

A Shotgun Pattern

Tyler LinstenInvesting

 

This data from Vanguard is so good it requires its own post. “Average” is what all long-term investors can expect to get over the span of decades, but at the same time they’ll rarely get what’s considered to be normal on a yearly basis! Such an important concept to explain:

 

Chart courtesy of Business Insider

Vanguard’s data via Business Insider

 

Newton’s Law of Finance

Tyler LinstenPersonal Finance

Screenshot 2015-12-29 at 9.44.11 PM

It’s really hard to start a new financial habit and in some cases it’s even harder to change one already in place. We have routines, tendencies and grooves worn in the pathways where our money flows. After all, it’s basic physics: an object in motion will stay in motion unless acted on by an outside force. Your habit is that moving object and sometimes it’s necessary to take action and change its direction, or to stop it completely.

Changing habits is not an easy task but this simple chart shows it gets much better after that first step. Since money triggers such emotion in most people it’s understandable we take great effort to avoid making decisions and changes. The bright side: the first step is just like any other task at its core. The worst step of getting a nagging toothache fixed is making the appointment, right? Once the appointment is made, it’s all downhill from there – usually it’s the time spent thinking about committing to get to the dentist that brings the most anxiety instead of the procedure itself. The same goes for financial habits. From opening a new high-yield savings account, to logging in to bump up a 401(k) contribution, or scheduling auto-pay to reduce a loan balance, the hardest part of a positive financial habit really is the first step.

I’ll bet you nearly every single Step 1 in the hopper takes two minutes or less!