I recently received a listener question that I’m all too familiar with. Over the past twenty years or so, of my career, I’ve fielded one question thousands of times. It’s been asked in a variety of different ways but it all comes down to the same basic point. I’ve even had a few close friends, who have never needed the services of a financial advisor, suddenly come into windfalls that are now prompting them to ask this question. The question? What is the average cost of an investment advisor? More specifically, what is the average cost of hiring an investment advisor to manage $1MM or more?
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As I said before, I’ve received some variation of this question more times than I can count. What made this particular question so interesting is the fact that the listener included a dollar amount. A quick Google search on this subject doesn’t really yield a lot of variance in the answer. Most of the results are generally in the ballpark of 1 percent. Therefore, on $1MM, you’re probably going to pay around $10K. However, that isn’t really the true answer. But why?
Oftentimes, investment advisors charge a percentage of assets under management (AUM). Many view this compensation arrangement as a win-win situation because it places the advisor and the client on the same side of the table. If the money you’ve invested appreciates, you’re going to pay a little more but if it depreciates, the advisor loses money as well. Typically, this is preferable to having a salesman attempt to sell you a product. But this question is interesting because it didn’t ask how much it costs for an advisor to manage $50K. It doesn’t even ask the average cost of hiring an investment advisor to manage $250K. Why does that matter?
Well, each of those dollar amounts carries different price points. In fact, the fees are often greater on smaller investments. For example, let’s say you have a $50K account and the advisor is charging 1.2 percent. In this case, the advisor is getting paid $600 annually, assuming no growth. On the other hand, if you have a $5MM account and the advisor is charging 0.84 percent, you’re paying them $42K each year. But where did I get these numbers? Are they just random figures pulled from a hat?
Michael Kitces is a colleague of mine in the financial world. He owns a publishing company called kitces.com that conducts all kinds of research. His company recently conducted a survey amongst financial advisors and found that advisory fees range from 0.5% (for assets over $5MM) to roughly 1.25% (for assets under $250K). I’ve included some of the infographics from this survey for you to explore as we unpack their findings. Even by their research, a $1MM portfolio is going to cost about 1% in advisor fees.
Now, in my neck of the woods, I can run a short distance up the road to a national chain and, where we might charge 1.2 percent, they charge 1.75 percent. On the other hand, I have a friend that works for another firm in the area and they charge 1 percent. These are the advisor fees; the cost of having that person sit down with you to advise you on your portfolio. Therefore, I can vouch for the fact that—within just a few blocks of my own business—there are some advisors who are a little less expensive and there are some who have a considerably higher cost.
However, here’s where things get interesting. These fees don’t cover the mutual funds, the index, or any types of trading fees that may be in the account. According to Bloomberg News, it isn’t uncommon to see fees ranging from 0.65 to 0.89 percent on actively managed mutual funds. Likewise, index mutual funds can carry an additional fee of 0.11 percent. At the same time, the SEC warns that you could incur redemption fees when selling shares within a certain timeframe. There are also exchange fees that you could face if you transfer your investments into another fund within the same family of funds. And finally, you could be charged account fees if your account balance falls below a certain amount.
This is why I often tell people to not get hung up on the advisor fee. Instead, look at the total fee. Let’s say you hired an advisor who carries an advisory fee of 1.75 percent. If you built a mutual fund portfolio that carried fees of 0.89 percent, you’re now looking at a total cost of 2.64 percent. On the other hand, if you hired an advisor with a 1 percent fee and minimal additional fees for your various investments, you could be paying as little as 1.1 percent. So, the total fee matters.
Even if an advisor is charging a slightly higher advisory fee, they could end up being considerably less expensive than one who charges a lower fee but tacks on several additional fees to manage your portfolio. But the question was actually, “What is the average cost of hiring an investment advisor to manage $1MM or more,”. The average advisor fee is likely going to be somewhere around 1 percent but the average all-in cost is usually between 1.5 and 1.75 percent on $1MM. But is there a less expensive way?
A relatively new term, Robo-advisor, made its way on the scene about five or six years ago. Basically, this is an algorithmic service that manages your money. Robo-advisors can cost between 0.25 and 0.5 percent, depending on the size of your portfolio. You’re probably thinking, “Man, I can pay a face-to-face advisor 1 percent or a robot 0.5 percent? That seems like a no-brainer!” It’s true. They are less expensive. But are they the best choice for your wealth management?
The answer to this question is going to be subjective. Perhaps that is the best option for you. Maybe it’s not. When I examine this question in my own life, I ask myself, “As a business owner, which is the best for me? Human or robot?” Fortunately, we have a lot of data on this now. There was a study conducted by Vanguard—the low-cost leader and one of the world’s largest investment companies—called Quantifying Vanguard Advisor’s Alpha. They found that hiring a human advisor brings much more to the table than we often realize.
In the Vanguard study, they measured the value added by basis points (roughly 1% of account value) and found that the cost-effective implementation provided by a human advisor could add up to 34 basis points. Similarly, tactical rebalancing performed by a human advisor potentially added 26 basis points. However, the biggest potential gain in added value came through behavioral coaching, something you cannot receive from a robot. The Vanguard study found the added value of behavioral coaching was could possibly equal 150 basis points. Additionally, asset allocation saw an average potential ranging between 0 and 75 basis points. Spending strategy could yield between 0 and 110 basis points while the total return vs. income investing saw the possibility of significant added value but couldn’t be quantified due to the individual nature of it.
Vanguard is known for being the low-cost leader in investing. They’ve built one of the largest investment companies in the world based on that premise. Likewise, they own several of the Robo-advisor services on the market. Despite this, they recognized that by hiring a human advisor, you could potentially see up to a 3 percent increase in net returns. There are just some things that algorithms can’t do for you.
As business owners, we understand that in order to be successful in business, we must be willing to take risks. But this has a side effect that can be harmful to our overall financial health. You see, because we’re so used to taking risks in our businesses, this mindset often carries over to our investments. That’s why I thought it so intriguing that Vanguard found that behavioral coaching was the area with the greatest potential added value.
In my 20 years as a financial advisor, I have helped thousands of clients. In my experience, the ones who have done the research and reviewed the academic studies are often the ones who cause themselves the greatest harm. I’m reminded of a story about the Manhattan Project. When they were working on the atomic bomb, they actually hired high school girls to come in and work on some of the projects. The engineers gave the girls a set of written guidelines to follow. What’s interesting is that when the engineers had to monitor these projects, they wanted to tweak things. As a result, they ended up performing at a lower level than the teenaged girls.
They weren’t following their own guidelines. They thought they were smarter than themselves and ended up hindering their progress by not trusting the guidelines they had written. The same is often true when we get involved in our own investments. We think we can do better than our own strategy. It’s why I don’t manage my own money. I probably know more than the average business owner when it comes to investing. But I understand that I am too close, too attached, too emotional to properly handle my own investments.
Friends, don’t attempt to handle your investment portfolio on your own. Hire a trusted financial advisor and reap the benefits of behavioral coaching and personal accountability. You could hire a Robo-advisor. But they’re not going to stop you from pulling your money or reallocating assets in ways that are counter to your financial goals. If you don’t have a financial advisor, reach out to us. Our team has helped thousands of clients through comprehensive wealth management and behavioral coaching.
Look, I know life is hard but it’s still so good. Looking at the average cost of an investment advisor and choosing between a human and a Robo-advisor can be frustrating. But it doesn’t have to be. By weighing the pros and cons and measuring the added value of a competent financial advisor, you can make the choice, at least, financially simple.
As financial advisors, we understand the value of a good financial planner. So much so, that we trust them to manage our own finances. Don’t try to handle something this important on your own. Reach out to us. The team at Financially Simple is ready to help.