Most people wouldn’t want a loon managing their money. But perhaps they should reconsider. Low cost fee-based advisors—especially those building indexed portfolios—aren’t exactly normal.
To determine how strange they truly are, let’s examine what’s typical. When I first met my wife, Pele, she invested with an adviser through Raymond James Financial. He was normal to a fault.
For Pele to make money, her mutual funds would have needed to earn 6.25 percent per year, before fees. She owned a portfolio of actively managed mutual funds with expenses averaging 1.5 percent. Her advisor charged her a portfolio wrap fee, costing an additional 1.75 percent. That’s a total of 3.25 percent, really high for the U.S. but fairly typical for investors in other countries. Add the increasing cost of living (let’s assume 3%) and her fund managers would have needed to generate 6.25 percent just to keep pace with inflation.
Pele’s advisor was normal. With financial dreams of his own, a mortgage to pay and kids to feed, he was much like the rest of us. If given the choice between earning $200,000 a year and $100,000 a year, he would have selected the former. Most people would.
Companies like Raymond James Financial, like so many other advisory firms, reward advisors that generate higher fees. In a 2007 article published in the U.S. weekly industry newspaper, Investment News, Raymond James representatives are reported to earn higher compensation for higher commissions charged to investors:
“…the new deferred-compensation program this year gives a bonus 1% to affiliated [Raymond James] reps who produce $450,000 in fees and commissions, a 2% bonus for $750,000 producers and 3% for reps and advisers who produce $1 million.”
Pele’s account was costly. Because she was financially uneducated, her advisor charged her heavily. He reaped a financial reward, while the firm got the remainder. But don’t blame the advisor—or the firm. It’s all completely normal. Odds are that your advisor is normal too, whether you have hired your brother-in-law, your neighbor, or your best friend’s girl from college. But do you really want what’s normal?
Paying a seemingly paltry 2 percent investment fee might seem reasonable enough, until you work out the damage.
A $100,000 portfolio over 30 years at 9 percent grows to $1,326,767. With a 2 percent extra fee, it would only grow to $761,225. Whether you have 30 years left to build your money, or you’re hoping to bequeath it once you’re gone, small percentages pack big punches.
With an abnormal advisor, however, you would take less of a hit. I’m talking about the kind of person who would put your earnings potential ahead of theirs. They share similar traits with someone who may have stood between you and a schoolyard bully. It’s altruism as its best. There are easier ways for them to make money—and they know it.
Normal advisors (and can you really blame them?) pluck their fish from barrels. Variable annuities and their high commission fees are a Christmas bonus with every sale. Front end loaded mutual funds help make exotic car payments. Mutual fund portfolio wrap fees (like my wife once paid) are icings...on top of multi-levelled cakes.
Many fee-based advisors shudder at the above. Disinterested in easy money, they would rather see you profit. If you find a low cost, fee-based advisor, that’s great. If they’re willing to build portfolios of index funds, that’s even better. They may have a save the world complex or a few eccentric tics. But that’s what makes them lovable, and profitable for you.