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SMay 16, 2012

Managing Your Money Can Cost a Lot--- or Very Little

Scott Burns

Q. We have been retired for 6 years. We are beginning to question the fee for our rollover IRA. What should we expect as an average fee for fund management by a fee-based financial planning firm? Ours is a diversified portfolio of about $300,000. We also have a 10-year $200,000 annuity due to double by 2017. —M.D., Torrance, CA

A. In theory, what you pay will vary with the level of service you receive. But what you pay is also higher for smaller portfolios than for larger portfolios. Major brokerage firms like Merrill Lynch, for instance, are now discouraging brokers from handling accounts under $500,000 by reducing the commission payout brokers receive on such accounts. What you pay will also depend on whether your advisor is working in a fiduciary capacity or in a sales capacity. In general, those working in a sales capacity— earning some or all of their income from sales commissions— will cost more than those working in a fiduciary capacity. Here is a list, in descending order, of expenses you can expect:

  • The Insurance Sales Channel. Products like variable annuities and insurance sold mutual funds tend to be expensive. Typical costs run well beyond 2 percent a year, not including sales commissions. Your annuity "due to double" in 2017 is a sales driven product. If you check the illustrations you were provided you’ll find that the actual cash value of your annuity is not going to double. The amount that doubles is used to determine your annual withdrawal rate. Such products have total costs of about 3 percent a year.
  • The Legacy Brokerage Channel. The traditional brokerage houses— Merrill, Morgan Stanley, etc.— generally target making 2 percent on client assets a year. This can be done in commissions for trades. It can also be done with "wrap accounts" where you pay a percentage of assets under management to cover all expenses of the account. A $300,000 account would likely be charged about 2 percent a year.
  • The Traditional Registered Investment Advisor Channel. RIAs are supposed to function as fiduciaries, always putting client interests first. Typical charges run from 1 percent to 1.5 percent but are negotiable, particularly for large accounts. RIAs may build portfolios of individual stocks but they are increasingly likely to build mutual fund or exchange traded fund portfolios. When this is done you need to watch the total cost.
  • The Low-Cost Registered Investment Advisor Channel. These advisors seldom provide financial planning services, arguing that financial planning needs vary and should be done on an hourly basis rather than rolled into the cost of asset management. Some of these firms are Internet based. All-In expenses with these firms can be under 0.70 percent. This is the same as the expense ratio for some of the larger lifecycle mutual funds offered by firms like Fidelity, T. Rowe Price and American Century. These outfits will not walk your dog, but they do manage the assets.
  • The One-Stop-Shopping Channel. Cost-conscious investors can also buy a single mutual fund that will give them a broadly diversified portfolio. The lowest cost options here are Vanguard Wellington and Vanguard Wellesley, both high performing, well-rated managed funds that cost less than 0.20 percent for Admiral shares. Some brokers in the legacy brokerage channel will offer you a similar fund from the American Funds family, such as American Balanced A shares which costs 0.62 percent a year but also involves a front end commission.
  • The Do-It-Yourself Channel. The self-motivated investor can get asset management costs down to 0.10 percent, the cost of Admiral shares for the Vanguard Balanced Index fund. The same investor can build and manage a variety of "Lazy Portfolios" built with index mutual funds or with more widely available exchange traded index funds. These portfolios can be built at a cost of 0.15 to 0.30 percent a year, the average cost of the underlying funds.

With typical balanced funds now providing dividend and interest income of about 2 percent of portfolio value it is good to be very concerned with the total expenses your retirement nest egg faces. Basically, it comes down to a choice of who gets the income— you, or your money manager? Since there are major and well-known mutual funds that will manage a broad portfolio for you for less than 0.70 percent while showing long track records of superior performance, the burden is on anyone who costs more to demonstrate that they offer something to justify their additional cost.

Filed Under: Income Investing