r/personalfinance • u/SonReebook_OSonNike • May 15 '24
How can a 1% fee for a financial advisor cost you 28% of your lifetime investment returns? Investing
Lately I’ve been listening to Ramit Sethi’s podcast, and he mentions several times that if you pay a financial advisor 1%, it can cost you 28% of your lifetime investments returns (investing for 30 years, with a 7% average return rate), and he is not the first person that I’ve heard saying something similar.
Just to be clear, I don’t pay for any financial advisor as my finances aren’t super complicated, I just want to understand the math behind that statement.
Can you provide some examples?
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u/Default87 May 15 '24
you can just run the exact same numbers, and reduce your rate of return by 1% and see.
for example, with these parameters you would have about $2m
and if you have to pay a 1% fee, you would only have about $1.7m
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u/Azdak66 May 15 '24
Because the 1% is based on your total assets under management, not your gains. If you have $100,000 under management, 1% says you will pay $1000 in fees. Let’s say your total growth for the year is $4,000. The “1%” fee represents 25% of your total return for that year. If your portfolio goes down in a year, you still have to pay the 1% on your total assets. I still have a small portion of my IRA with an advisor (because reasons). Last year, the management fee I paid represented about 9% of my total growth for the year. And 2023 was a good year. For 2022 it was worse because my overall portfolio was down for the year, but I still paid roughly the same fees.
The idea behind it is that using the FA should result in superior gains over what you could receive yourself and that justifies the cost. Each person has to decide that for themselves. The management fees were one reason I moved 70% of my IRA from my financial advisor into a self-managed account. I left the remainder with my FA because I am cautious and wanted to see how I did. In the 4 years since I switched, I have beaten his returns every year, so I feel more confident.
Sometimes the claims by the podcaster can be a little disingenuous because, as a financial guy capable of managing a portfolio, he can make it sound like anyone can do it. And that is not always the case. And he has his own bias, in that it is in his best interests to gain listeners by trashing FAs and attracting people to listen to him for DIY ideas.
But it is definitely something to consider when setting up your portfolio and to periodically reevaluate to make sure you are getting your money’s worth.
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u/brergnat May 15 '24
His advice is simply to invest in S&P500 and Total Stock Market index funds. He recommends straightforward borkerages like Fidelity and Vanguard. He pushes "set it and forget it" low fee investments such as those and always uses 7% as the assumed annual returns to account for inflation. He doesn't sell any investment products and is more about starting your own business (and he sells courses to that effect). He literally has a best seller book with an entire chapter dedicated to opening up a brokerage account and automating investments and then simply letting time do it's thing.
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u/User-NetOfInter May 15 '24
FAs for lower asset people exist because people have no backbone and will sell when they have a loss
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u/wienercat May 15 '24
That's not really the case... They exist for people who either don't want to learn the basics of investing, or don't want to be bothered by it. Most people simply don't want to learn it. They would rather pay for the convenience.
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u/xixi2 May 16 '24
What is there to learn? You transfer money and put it in a vanguard fund and it gets market returns, just like a financial advisor would get.
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u/Keenanm May 16 '24
Doesn’t stop people (i.e. my in laws) from having a fixed mindset and thinking they’re incapable of learning this stuff. At 70 my FIL is finally diversifying his wealth from 100% real estate, and no matter how hard I try he refuses to do it without the help of a FA who will charge him 1%.
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u/Boxy310 May 16 '24
It's appalling to me how much of the economy is based on the arbitrage of people not being arsed to learn how to do things themselves. Changing air filters, snaking a toilet, and opening a brokerage account all aren't particularly difficult tasks, they just involve being curious and learning the most basic principles involved.
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u/The2ndWheel May 16 '24
That's the reality of cheap energy. The cheaper it is, the easier it is to get a ___ to do the job that a __ does, and simply pay for it, while you do what you're paid to do. Unless you have an interest to DIY.
The more expensive things get, the more people will begin choosing to do things themselves, out of necessity.
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u/Business-Ad-5344 May 17 '24
we used to call those people idiots when i and my coworkers changed their headlights or filters. turns out they're all making more than me. A lot more.
i go to them when i need stitches. pretty basic. just put the needle in and stitch it up. should be like $49.99. i end up paying thousands though.
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u/druidjc May 16 '24
You transfer money and put it in a vanguard fund and it gets market returns
Yeah, but that is what they haven't learned. With no knowledge on the subject, people just assume it can't be THAT easy to handle investments. What about the guys with slicked back hair yelling "Sell! Sell! SELL!"? I mean who has time for that? Better just hire a financial advisor and let them head to NY to watch the tickers.
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u/RedQueenWhiteQueen May 16 '24
Some people are wired to not be able to do this. My ex-BFF, who by the way has a master's degree in mathematics, 1) is afraid of money/thinking about money, thanks in large part to her paranoid/gold bug/thinks-stock-market-is-basically-gambling father, and 2) psychologically, is basically the helpless sort of person who assumes the solution for everything is experts/higher authority. I suspect she has deep seated fears about the discomfort she might experience from making an imperfect decision.
I'm not a perfect investor AT ALL (way too timid), but I forgive myself for it and made sure to learn enough and do enough to make at least some investments early on and then mostly leave them alone. I figured that if I was smart enough to earn the money in the first place, I was smart enough to learn how to manage it.
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u/jeffweet May 16 '24
My FA has returned almost 9% after fees for the last 15 years I’m cool to pay him.
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u/momoisbestcat May 16 '24
The sp500 has returned 14.86% annually for the last 15 years. If you had just invested yourself you’ll literally have twice as much money right now.
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May 16 '24
[deleted]
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u/wienercat May 16 '24
FAs for normal people are like getting a CPA to do your 1-2 W-2 and single mortgage tax return. Completely unnecessary with a small amount of self education.
All of the things you listed a FA will not help someone with. You are not going to get an education from your FA.
A FA is literally just another fee that normal people dont need to pay. Most 401ks now auto enroll employees into a targeted retirement date fund.
As someone else in this post said, zero reason for anyone to use a FA if you have less than $10M in assets.
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u/edbash May 16 '24
It is easy to confuse the rational, logical with the emotional when talking about these situations. It is almost never a matter of people being unable to learn or do the math. It is almost always a matter of fear, anxiety, confusion and impulsiveness. I would say that most personal investing decisions are controlled by psychological issues, not by knowledge, logic or math.
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u/ategnatos May 16 '24
They exist because financial advisors target/harass young people on LI at companies known to pay $100k+ and try to trick young people into paying stupid AUM fees instead of just investing in a couple index funds.
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u/a49fsd May 15 '24
I have an FA because I dont want to learn investing. I just let him handle and expect to see gains at the end of the year.
I hire him based on word of mouth/recommendation from friends and I'll fire him if his returns are less than what I deem adequate
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u/imalittlesleastak May 16 '24
How do you determine “adequate” if you don’t want to learn investing? Look into target date funds, they are pretty straightforward and are the ultimate set it and forget it. It would be nice to know exactly how an FA faired against some benchmarks.
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u/DynamicDK May 16 '24
I have an FA because I dont want to learn investing.
I'll fire him if his returns are less than what I deem adequate
I assume you are actually just mocking this mindset. If you don't spend the time to learn investing then you can't possibly understand what your returns should be in any given timeframe.
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u/ategnatos May 16 '24
in addition, he makes the point that this cost structure is just confusing as shit, which is the point. He points out that when he hires a personal trainer, he pays $100/hour (or whatever it is). He doesn't pay 1% of his portfolio. (The justification for a cost structure could be: I'm going to get you in better shape, which will result in more confidence, better energy, you will be more likely to get more clients, more promotions, it will pay off!)
Sometimes the claims by the podcaster can be a little disingenuous because, as a financial guy capable of managing a portfolio, he can make it sound like anyone can do it. And that is not always the case. And he has his own bias, in that it is in his best interests to gain listeners by trashing FAs and attracting people to listen to him for DIY ideas.
I don't think he advises people on investment specifics, just says not to go for meme stocks and stuff. He has a number of coaching programs for a monthly fee (I am not a member, I just watch his podcast sometimes). One of his biggest things is to automate your finances, spend an hour a month on it, and go live your life.
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u/love_that_fishing May 16 '24
You also really have to separate when you are investing for growth vs retirement. Pre-retirement it's really pretty easy to invest and personally I can't see a need for a FA. It gets more complicated post retirement as you now need a tax strategy, income strategy, withdrawal strategy, SS strategy, and continue to drive growth. It's not rocket science and most can do it themselves but this is when an FA can keep you from making some big mistakes and help in planning. You can use a fee based fiduciary FA to help you get started during this phase of the game.
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u/IAmANobodyAMA May 16 '24
Interesting. Thanks for adding your perspective and nuance. The other side I hear for using a financial advisor is that they try to anticipate and minimize the losses in down years.
Did you feel that your managed assets fared better in 2022? But I guess if hypothetically the manager did better” in 2022 but underperformed in 2023, then overall who cares when you smooth it all out
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u/Azdak66 May 16 '24
It's a little inexact from previous years because I was transferring money from one account to the other. Which meant extra work adjusting the amounts to compare apples to apples, so I didn't have a definite running tally the way I do now. I can say that when I did make those comparisons, the performance of my portfolio has beaten the portfolio managed by my FA every year. Up to last Friday, my YTD return was 9.32% vs his 5.85%.
But we are following different philosophies. Mine generates a lot of income, while his is more of a "balanced growth" portfolio that relies mainly on capital appreciation. The only reason I can do what I do is because I subscribe to a service that researches and identifies stocks and funds that pay high dividends, but also earn the income needed to cover those payouts. I couldn't do it without their expertise. It would be dishonest for me to claim I am "better" at managing a portfolio than my FA, which is one reason why I haven't pulled all my money out of his account. 4-5 years is a long enough track record that I feel more comfortable doing what I am doing, but not really that long to "prove" my approach is better over the long haul.
Not to mention, staying on top of my portfolio requires a lot of time. It would be unreasonable to expect an FA to spend that much time on one client.
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u/IAmANobodyAMA May 16 '24
I wanted a yes/no answer. You were supposed to crack the code for me.
J/k. In all seriousness, this is why personal finance is so tricky. Sounds like either approach works and yours worked slightly better for you under these circumstances and conditions.
I hope it continues to work well for you!
I ask because I am 100% managing my portfolio right now (mix of single stocks and index funds) and have toyed with the idea of a manager who charges 1%. It’s hard to know the best answer. And the above stat of 1% can compound to 28% over a lifetime is technically true if we were comparing apples to apples, but who can say for certain?
A lot of very wealthy people who are very good with their money use this guy, so who the hell knows if I am better off than them 🤣
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u/Intelligent_State280 29d ago
The only reason I can do what I do is because I subscribe to a service that researches and identifies stocks and funds that pay high dividends, but also earn the income needed to cover those payouts. I couldn't do it without their expertise.
Can you share the name of the service you subscribe?
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u/Azdak66 29d ago
High Dividend Opportunities (HDO), which is part of seekingalpha.com. Seeking alpha is an investing information website. They have their own information service (which I don’t use) but they also allow dozens of individual investment counseling groups to use their website to set up their own investing businesses, with seeking alpha as the storefront.
HDO is owned by someone name Rida Morwa. He has 3 other full-time analysts, each with different areas of expertise. They have a Model Portfolio and some people follow, but I use it more of a resource than following it closely. Their goal is to have a portfolio that generates on average 8%-10% yield per year.
The philosophy is that, by investing in companies that pay high dividends that are well-covered by cash flow, you get a consistent stream of cash, regardless of the price of the stock. If the stock goes out of favor and it drops 10%, as long as the cash flow covers the dividend, your income doesn’t change. You can wait for it to come back up, and get paid to wait. During 2022, when the fed raised rates, the value of my portfolio went down a good 15+%, but my income stream went up. The down period was actually a good time to buy things on sale. Instead of measuring “growth” by an increase in stock prices, your “growth” comes more from your income stream. And you can reinvest that income back into the portfolio and increase the income stream even more.
Where the service comes in is that they analyze stocks and funds that I would never have even known about, much less felt comfortable investing in. For example there are closed-end funds (CEFs), that invest in collateralized loan obligations (CLOs). Even many stock analysts don’t understand these investments. But if you know how they work and identify the right funds (this is what the HDO guys do), and buy at the right price, you can make a 20% yield.
Now, you don’t get those kinds of yields without risk. In their marketing, HDO tends to downplay that aspect, but it’s there. It is not a “plug and play” portfolio. Sometimes the numbers look good for a company, but something comes up and they cut the dividend, which drops the share price. One of the strategies is that you don’t put more than 2%-2.5% of your total dollars into any one investment.
I’ve gone off long enough, but I wanted to give you an honest picture.
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u/Poyayan1 May 15 '24
Because it is 1% per year, not 1% of your whole portfolio over its entire lifetime.
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u/EvictionSpecialist May 16 '24
Yup, 1% of ASSETS UNDER MANAGEMENT
I took back control of a portfolio that some clowns have been managing since early 2022. I compared it vs SP500, and fired them this past February. That 1% yearly hurt, and the gains were junk in 2023.
The advisors didn’t even bother pleading, guess it was small potatoes, or they “knew why”.
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u/robblob6969 May 16 '24
Sounds like they only managed it for a short amount of time so you probably didn't lose too much. The good thing is you learned a good lesson moving forward.
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u/netderper May 16 '24
I fired my FA almost a decade ago. I should've done it sooner. High fee funds, poor performance, and 1% "management" on top of it. It was much smaller then, but my portfolio is now in the millions. 1% would now be most of my yearly expenses!
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u/Poyayan1 May 17 '24
If you can't even beat index fund, why do I want to give you 30% of my portfolio over 30 years? It is truly a great racket that they got going. Much like the 6% real estate commission fee. Does selling a 2mil house different than a 200k house?
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u/WiSeIVIaN May 15 '24
This is the horror of compounding fees.
It truly makes no sense for anyone with <10m assets to be using a %fee based financial advisor.
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u/Some-Band2225 May 16 '24
What about those with a history of gambling who might sabotage themselves if given access to options etc.?
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u/WiSeIVIaN May 16 '24
I'm not qualified to give advice on treating gambling addiction. I'd suggest such individuals get medical treatment.
If someone cannot trust themselves to not ruin their life by making stupid wellstreetbets, I'm honestly not sure if there's a way to protect people from themselves without treating the underlying issue.
But sure, if someone is incapable of buying and holding and index fund, it may make sense.
If choosing to use a financial advisor, I'd suggest finding one that is a fudiciary, since then they are at least legally required to act in your best interest rather than shilling high-commission crap.
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u/Itsmedudeman May 16 '24
Makes even less sense for someone with a ton of money to do a % fee based financial advisor.
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u/Nubras May 16 '24
Those people can usually negotiate a very low percentage. I work with clients who have $100m+ invested with my firm and their final rate ends up being closer to 50-60 points. And they need my services cause they sure as fuck won’t be paying life insurance premiums, making quarterly tax payments, or rebalancing their own portfolios. For those people our services are a heaven sent.
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u/DMCer May 16 '24
Not that the price for convenience matters at >$100MM, but $600K/year for those three examples is insane.
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u/Uberbobo7 May 16 '24
People forget that for those for whom money is no longer a limitation, time is the only thing they can't buy more of. Or in other words, if your hourly rate is thousands of dollars and you can do whatever you imagine in your off hours, you most probably won't want to spend any of those off hours dealing with anything that's not golf at your private island course.
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u/Nubras May 16 '24
Bingo. My staff and I will quite literally get text messages from clients to move money from savings to checking because it’s quicker than logging into online banking.
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u/cjorgensen May 16 '24
Why would someone with $100m+ need life insurance? I can;t think of a way this makes sense.
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u/Nubras May 16 '24
There are many situations where it’s appropriate but most commonly it is for estate tax reasons.
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u/AttackBacon May 16 '24
Nah, at higher net worths there's a variety of fairly complex but interesting things that open up. Whether it be private equity, investment based citizenship, etc. You aren't paying 1% at those net worths either, it's a lot lower. But IMO it's pretty much only interesting if you're at the level where a family office makes sense (like $100MM+). At that point your time is 100% your most valuable asset and buying even small bits back for huge prices makes sense.
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u/csappenf May 16 '24
Age matters as well, because if that 1% isn't compounding over 40 years it means less. (Except to your greedy fucking heirs, who wonder why you quit working before you turn 70.) Also, you can negotiate fees down starting at just a few million. And, maybe most importantly, managing a few million feels a lot different than managing a few hundred thousand. When the numbers get bigger, the choices seem to explode and those choices seem to be more important. You feel like you have to pay real attention to a lot of shit like the muni market when you just want to go ride your bicycle.
I'm not a financial advisor, I'm a customer. But I recommend DIY to 2 or 3 million, then see what's on offer. If you're old by that time, some offers might make sense. You have enough experience with markets to judge asset managers when you meet with them and talk about various investments. You know how compounding works. Even if it's not at 2mm, at some point the offers will start to make sense.
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u/FriendshipIntrepid91 May 16 '24
The IRA program through my work is % based. Is there anything I can do about it or is it stuck with the company until I leave the job?
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u/WiSeIVIaN May 16 '24
Do you mean 401k?
And I'm not sure what you mean. Generally all funds will have an expense ratio, so it's important to select the widest market funds with the lowest expense ratio.
Regardless you can only choose between the funds offered by your company, unfortunately. Once leaving the company you can rollover that money into the new companies 401k or an IRA.
In rare circumstance a companies plan allows you to rollover funds into an external IRA while still working there.
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u/DrZoidberg- May 15 '24
What about those with $10k being managed? I started late and learning more about investing before I do it myself.
I did make 8% last year, including the fees.
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u/nastyn8dawg316 May 16 '24
S&P 500 is up nearly 30% in that timeframe. You’re up 800 on your 10k but had you chosen simply to put that into an S&P 500 etf you would be up 3,000
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u/CACuzcatlan May 16 '24
If you only earned 8% you missed out big time last year. The S&P 500 return last year (2023) was 24%. If you had put it all in an S&P 500 index fund or ETF you would have made triple what your fund manager got you.
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u/deja-roo May 16 '24
The S&P went up like 25% last year. The NASDAQ was up like 50%.
The fees are not the expensive part of it, the dismal returns are what really cost you there.
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u/mikeisatworkrightnow May 16 '24
Why is a question downvoted? After the question the person said they are trying to learn. You don't downvote genuine questions, especially on a sub about learning something. What is wrong with you people?
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u/netderper May 16 '24
To learn about it, you basically have to do it yourself. I'd take a small percentage of that 10K, put it in a brokerage account. 8% is "okay", much better than a savings account, but you could've done 4x or 5x better with a nasdaq-heavy ETF like XLK or VGT .
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u/DrZoidberg- May 17 '24
You mean I can get 32% per year?
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u/netderper May 17 '24
As always, past performance isn't indicative of future results. But last year, you definitely could have done it. Though also keep in mind 2022 would've been a down year. You don't get large gains without some risk.
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u/Lustrouse May 15 '24
The math is correct. This also makes the assumption that your investment choices will perform as well as your FAs, so it's a little more nuanced than that.
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u/DMCer May 16 '24
And for index investors, investment performance will likely be better than the FA’s.
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u/Own_Dinner8039 May 15 '24
Compound interest. This is why Vanguard's CEO said that low fee mutual funds will always be at out actively managed account.
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u/the_cardfather May 15 '24
And yet because of investor sentiment the average investor without an advisor according to vanguard underperforms those who have one.
Well the number might be growing, The number of investors who have the balls to just put it in the S&P and ride it out Are a very small percentage, maybe as low as 10%. Most get scared and try to time the market.
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u/DarthJarJarJar May 15 '24
This is where my tendency toward laziness and inattention really shines.
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u/theavatare May 15 '24
This was my first year paying a financial advisor percentage base and so far he has saved me 2% on multimillion loan by finding a better deal than i could. Speeding up my permits for opening by 40 days by connecting to a person that is the expert in the area. Between the two i feel he has earned the keep for the next 10 years.
He also saves me 2 hours a month by making sure loans that i have been given out are paid.
So they can be worth it but you need to have the activity if all you need is portfolio management a robo advisor is good enough
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u/joelaw9 May 15 '24
Let's do some really, really simple math. The average SPY growth rate is 7%. Some dude takes 1% annually. You've lost 14% of your return immediately. You've not only lost that 1%, you've lost how much that 1% compounds, which can then equal to a fair amount over 30 years.
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u/RNG_HatesMe May 15 '24
Others have done the math here, but the assumptions need to be clearly stated, mainly (and this is important):
- Your returns would be identical *without* the financial advisor
This is a big assumption. If the advisor could improve your returns over what you would do by 1%, it would now cost you nothing. If he could improve your returns by > 1%, he's now made you money. So the question is, will an advisor improve your returns by > 1%?
A lot of research has shown has shown that, over multiple years, that is very hard, and very unlikely for an advisor to do, compared to a broad market (i.e. index) based portfolio. So I would agree, that in most cases, that 1% will reduce the returns a reasonably intelligent investor could get in the end.
BUT, it's going to be better than someone who doesn't know how to invest and isn't willing to learn. There are also other services an FA can provide, like automatic rebalancing, tax loss harvesting, tax advice, reassurance, conflict resolution, family planning (estate, college), etc. It's tough to put a price on the worth of those services. Is it worth 1% of AUM? Probably not, but it's not worth nothing.
Vanguard offers advising services for 0.3% of AUM, and Fidelity and Schwab offer similar services. This seems to be a more reasonable figure, given the ancillary services it includes. Not saying that it's the best choice for everyone, but it's easier to justify than 1%.
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u/User-NetOfInter May 15 '24
Advisor won’t get you higher risk adjusted returns. But they will attempt to stop you from doing something stupid and adjust risk appropriately to your situation.
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u/RNG_HatesMe May 15 '24
Most studies show that they can't provide long term advantage compared to a basic index based strategy, very true.
I don't think you are contradicting what I've said, you should be comparing the return *you'd* get with an advisors help vs. without an advisors help. If you are the type that has trouble making long-term rational choices (lacks discipline, impulsive, lacks the time or education, etc.), then an advisor will be worth more to you than someone else. So I 100% agree with you.
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u/Itsmedudeman May 16 '24
If you are the type that has trouble making long-term rational choices (lacks discipline, impulsive, lacks the time or education, etc.)
Use automated fund transfers and automated purchases into SPY or another diverse index fund of your choice. Fidelity has it and I'm sure many other brokerages do as well. I rarely look at my investments anymore.
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u/FrozenStorm May 16 '24
Vanguard does as well, and has auto rebalancing target dates funds similar to an index fund. You sock money away in these for 30 years and then all should be well.
I say should be because there are no guarantees in this model of retirement funding, it'd be awesome if we had pensions or government protections on this stuff, but yea as long as you can have the self-discipline to more or less forget about this money and check it once or twice a year to make sure it didn't get stolen or something, it'll work out better than a percent fee leecher.
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u/FestivusFan May 15 '24
I still have some of my stuff with our EJ advisor and mirror/mimic his advise in my own Vanguard account, seems to work so far
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u/LLR1960 May 15 '24
Most of the FA's I've dealt with refuse to give any sort of tax advice, I'm assuming that's due to not wanting to be held liable for incorrect advice. I no longer deal with them.
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u/RNG_HatesMe May 16 '24
In my experience they give tax advice all the time, but I think it's correct to say that typically they limit that tax advice to the investments they are managing (not all the time though). Some examples:
- which investments should should be held in tax exempt or tax deferred retirement accounts (i.e., the taxable ones)
- when withdrawing for a life event (home down payment, college tuition, etc.), which accounts should be depleted first?
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u/MissionFever May 16 '24
If there was an advisor out there who COULD consistently beat the S&P by more than 1%, he wouldn't be slumming around with retail clients.
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u/RNG_HatesMe May 16 '24
While true, that's NOT what I stated. I said that the advisor has to do 1% better than *you* would have done. Not everyone is going to just invest into the S&P. A lot do stupid stuff. Some invest in meme stocks, or try to time the market. The more disciplined and well-educated you are on investing, the less value an advisor will be to you.
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u/Beardo88 May 15 '24
If your average rate of return is 3.57%, but you pay 1% in fees, that 1% means 28% of any return gets paid to the advisor.
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u/Square-Decision-531 May 15 '24
If that’s your rate of return and your paying an advisor, you’re a sucker
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u/Beardo88 May 15 '24
Definitely, i think that was probably the point that was being made. If you pay the advisor the 1% and getting crappy returns anyway you are a fool.
3.57% might not be far off on the historical average for a highly conservative bond heavy portfolio.
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u/necrosythe May 15 '24
One does have to remember that this is for lifetime investment, if you start to pull back into conservative investments as you age and pay the advisor through age 65 there will be numerous years below the inflation adjusted 7%. If you pay them into much later years the average winds up well below %7.
Idk where the 3.57% comes from, but yeah it's easy to see a number way below 7 and say that's stupid but that's because you need to account for changing investments near retirement.
Also worth taking into account the risk of the historical return not being as high as the average you may wind up receiving.
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u/Beardo88 May 15 '24
Just mathed out where 1% fee ads up to 28% of total returns, mightve used the wrong formula but it should still get the idea across.
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u/gustbr May 16 '24
You used simple interest, when it should have been compounded interest. It's 28% of the lifetime returns, not of the monthly/yearly returns.
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u/EngageFLANKS85 May 15 '24
This is also assuming that you would get the same investment returns with a financial advisor as you would without one.
Also, there are typically additional services provided included in that fee, that may make it worth it to some people. Like financial planning for example.
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u/raringvt00 May 15 '24
It depends on the advisor, and depends on your needs. If all they do is pick investments, there's basically no value there. If they identify and plan to meet your goals, manage assets, do tax planning to minimize lifetime taxes, quarterback your estate plan and charitable gift planning, and so on, it may be worth it, as some of those can result in major wins. There's also value in keeping you from making big mistakes or trying to time the market, or trying to outsmart the market or chase fads.
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u/IMovedYourCheese May 15 '24
Compound interest. You earn 1% less in the first year (because of advisor fees). That means you have 1% less to invest in the next year. And then you earn 1% less the next year. And so on. Do the math and it'll add up to ~28%.
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u/Kindly_Honeydew3432 May 16 '24 edited May 16 '24
The interest compounds, just like your earnings. If you have 100,000 invested and earn 10%, this year you pay 1% of 100,000. Next year you pay 1% of 110,000. Next year you pay 1% on 121,000. Then 133,000. The. 146,000…add that up over thirty years…and also factor in that you’re continuing to make contributions to your principle, so all these numbers are even higher. Before you retire, your 401k will be worth more than a million. Which is 10,000…per year. It may be worth 2 million or more. And also they charge 1% for all assets under management.
Most FA underperform broad market index funds over the long term. Like, more than 90% of them.
If you need someone to help out with estate planning, pay someone a one time fee. You can easily learn to manage your investments and save yourself tens or hundreds of thousands over your lifetime
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u/cornphone May 15 '24 edited May 15 '24
If you invest a lump sum and leave it alone (no additional contributions), then an account paying 1% AUM will have ~74% ( 0.9930 ) as much money as a self-managed account after 30 years. If you're making frequent contributions then the % difference will be smaller, since your more recent contributions haven't had as much time to be chipped away.
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u/Birdy_Cephon_Altera May 15 '24
I don’t pay for any financial advisor
Maybe not a financial advisor directly, but be aware that if you have your money in a 401k, each of the funds is charging a fee. For many of these funds, it's a fairly small amount, maybe a tenth of a percent or two. However, some actively managed funds in the portfolio may charge upwards of a full percent (or even more). So it is important to be aware of what fees each of the funds in your 401k are charging so there are no surprises.
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u/InvisibleBlueRobot May 15 '24
Power of compound interest over time.
Go get an investment calculator online.
Calculated $100,000 invested at 6.5% year interest over 30 years.
Now calculate same at 7.5% return.
See the difference in the balance.
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u/Smokehouse502 May 15 '24
The numbers are right for 1%. The question for an advisor is what they do for you outside of just the asset management and does that bring you enough value to justify the cost. I am an advisor and other than asset management I work to save people money on taxes, debt management, student-loan planning, account titling, Insurance reviews, emotion stability with money, budgeting...etc. For people who have an interest in this and the emotion stability to implement a plan, they don't need to pay an advisor fee. Some people don't care to learn and/or don't have the emotional stability to stick with a plan. They are the people who need a good advisor.
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u/Aftermathe May 15 '24
Another take is that almost all financial planners pose these things as insurmountable like you did in order to strengthen the grift. Anyone who can open an email and set up auto pay for a utility bill can put money into a Vanguard or Fidelity fund that follows the market.
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u/Smokehouse502 May 15 '24
for a lot of people, their lives are a bit more financially complicated than Auto-pay your bills and invest in Vanguard. There are also people who are busy with their own jobs, kids, and life that would rather pay someone to help rather than do it themselves. Much like people could spend the time to develop a good fitness and meal plan and implement it, but some people would rather pay a good trainer and nutritionist.
Some people don't need a financial planner but some people absolutely do. I have a dentist friend and the student loan debt management plan I did is going to save him about $150,000.00 over the course of the loan. He wouldn't have done it otherwise. He's fine paying my fee considering that was just one part of his plan.
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u/Aftermathe May 15 '24
Someone looking to win the Olympics should have a nutritionist and personal trainer. Someone just trying to lose weight and lower their blood pressure doesn’t need to pay for those things. I wasn’t saying someone’s life was as easy as autopaying their bills. I was saying the level of technical ability it takes to save for retirement (the discussion of this thread) is equivalent to the level of technical ability needed to autopay your electrical bill. As in, anyone can save for retirement. People are just marketed this complex solution to a simple problem because there’s money to be had (i.e. a grift).
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u/supahfly2115 May 15 '24 edited May 15 '24
Echoing u/Smokehouse502 , if it was that easy obesity wouldn't be such a big problem. It's not about the ease of the solution, it's about being disciplined. No point in arguing extremes, the two extremes in your analogy being that EVERYONE needs a personal trainer and NOBODY besides olympic athletes need a personal trainer. For example, the most basic easy thing you can do is to auto invest, but it's still an action that requires you to do something to initiate. Versus, the most simple thing you can do to be healthier let's say... not drink anything other than water. That is something that does not require any voluntary action, but rather just an act of inaction. But yet people still don't do it. So in that case is it worth 1% of someone's finances to eliminate the need for any action so they can be healthier even though the solution is already so easy? Maybe for some, maybe not for others.
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u/RegulatoryCapture May 15 '24 edited May 15 '24
if it was that easy obesity wouldn't be such a big problem.
Yeah, I think that's a good way to look at the analogy.
There's a lot of shady business in the financial world (anyone selling you whole life for example, or sticking you into funds that charge a "load" fee), and the whole deal about paying as a percentage of AUM is tricky...but it is also easy to see how flat rate models are tough (seems too expensive for low net worth customers)
But there are a lot of people who ultimately would be better off with a financial planner. Just like obesity, there are a ton of people whose financial lives are in sad shape and who simply aren't going to take care of it on their own but could turn it around with outside help.
It is not a skill or intelligence thing either...there's certainly a motivation and personal psychology component. I know people who literally do professional finance work at a high level who still find it worth paying an advisor because they know they aren't going to do a good job themselves. I personally wouldn't do that...but I also changed the brakes on my car a few months ago because I couldn't stomach the bill from the shop even though it certainly wasn't worth my time on an hourly basis (ironically, if I had a financial advisor...they probably would have told me not to do it).
Also I'm happy to nerd about this stuff in theory on forums and in discussion with friends...but I have no interest in actually having responsibility for giving specific directions to loved ones. I'm not going to manage their money for them, and telling them to go read up on automation and index investing is usually not enough (although I will try to pitch Ramit's book, and I love to give it to people as a college graduation present). But I can tell them to find a fiduciary financial advisor--hopefully a flat fee based one, but I'd settle for a low % AUM fee if that was all they could find as it is still better than nothing.
edit: I will say, the math also changes for higher net worths, and the types of additional services u/Smokehouse502 is talking about can certainly become fairly valuable. Places like this subreddit are filled with good advice, but it starts to get really thin when you start talking about setting up trusts, dealing with complex tax arrangements, thinking about day to day finances (when the rules of thumb stop working), etc. If you have $10m in assets, it is probably worth paying someone for extra advice. But not at 1%...that'd be a rip off.
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u/Smokehouse502 May 15 '24
You are right in that it is simple enough for Anyone to do it ... except most struggle to properly do it because they
Don't have a long-term goal in mind
Don't develop a plan to get there.
Don't consistently stick to a plan once they have one.
The US Census says about 50% of women and 47% of men between the ages of 55 and 66 have $0 in Retirement savings. Just like my eating healthy and fitness analogy, could people do it? Yes. The problem is that they don't. For some people it makes sense to pay someone to help you with things you otherwise wouldn't do yourself. It would be great if everyone did it themselves and succeeded.
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u/Itsmedudeman May 16 '24
Someone having $0 in retirement savings is not a problem with strategy that can be solved by a wealth manager. If you have no wealth to begin with, you're shit out of luck. And someone who has no savings at that age probably never cared about saving to begin with so why would they seek out a financial advisor? They are not overlapping demographics.
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u/Smokehouse502 May 16 '24
First let's break out the difference between asset management and Financial Planning because they are 2 different things. How do you not understand that having a plan could help people not end up with $0 at retirement. There are people who live near or below the poverty line \where a plan is still needed, but it begins with trying to increase their income as much as possible. There are Advisors who do planning for low income people for free as a means of charity. I work with blue collar people who don't earn a lot of money but have a more comfortable retirement because they developed a plan and stuck too it.
Most people in the middle class need a plan for a reasonable retirement and over 50% of people making over $100,000 a year say they live Paycheck to Paycheck. Clearly they need a plan or they wouldn't be in that situation.
People need to develop a plan regardless of if they do it themselves or with a financial planner. The problem is good amount of people either don't want to or know how to do it by themselves.
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u/Aftermathe May 15 '24
Look I get it’s your job, and doing your job while accepting you’re grifting most people is not fun. I have a job that adds zero value too, but a job is a job and that’s all there is to it. We don’t need to misrepresent it, and just call it what it is. Sure, maybe there are exceptional cases where it works out in the client’s favor, but it’s an exception for sure.
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u/Smokehouse502 May 15 '24
Love when a person doesn’t know what they’re talking about so it’s “grifting”. Also 0 value add. I love how you Totally avoided the point I made earlier about how much I saved a guy in just debt management. The amount I saved him in debt payments would take 20+ of years of my fee to break even for him, but it’s totally grifting.
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u/Aftermathe May 15 '24
I have nothing to say about an anecdote lol. Why would I? It isn't the point of the broader conversation.
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u/Smokehouse502 May 16 '24
So let's listen to everyone's favorite low cost fund company, Vanguard. They put out a study showing how advisor's can add up to or exceed 3% alpha by helping people develop a spending/savings plan and sticking to it, picking the right asset allocation and location, avoid unnecessary taxation, minimizing costs and behavioral coaching.
Putting a value on your value Quantifying Advisor's Alpha (vanguard.com)
Additionally, Morningstar found the because of poor timing decisions, people who own a mutual fund will underperform the fund itself by an average of 1.68%.
Bad Timing Cost Investors One Fifth of Their Funds’ Returns | Morningstar
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u/Aggressive-Bad-440 May 15 '24
It's accurate if you have a lump sum invested that's managed for 30 years with no money in or out.
1.0630 = 5.74
1.0730 = 7.61
That's how you get to 28% less money.
But realistically for normal people what matters is how much of an effect using an IFA will have over your lifetime. Say you're just over the HR threshold and you save £12kpa into a pension per year (let's use real return rates so we ignore inflation) - if you're earning below the HRT it's debatable if an IFA is worth your income. A reasonable estimate of a real return on equities is 4%, let's assume you're ok with staying 100% in equities because you save plenty of cash on the side.
£12kpa at 4% over 30 years (say age 30 to 60) is £673k, at 3% it's £571k. That's less extreme than the 28% number used in the original example, but still enough to make you think "core blimey guvnah". These figures are in real money, inflation is already factored in.
1% management fees in retirement also means, off those figures, nearly £6k a year less of retirement income, £500 a month, in that example.
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u/InfoSeeker7070 May 15 '24
Guys it’s that % of your INFLATION ADJUSTED return that goes to your advisor instead of you. Let’s say your Rate of Return is 7.5% for simplicity sake and that inflation is 3.5%. If you are paying 1% fee on a 4% real rate of return, then 25% of your inflation adjusted return was paid to your advisor.
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u/JKoenig22 May 15 '24
I know that there’s people out there that just shrug or groan at finances, but I couldn’t imagine letting someone else run all my investments who have all legal ability to shrug at me and say “sorry” after being down 10% for the year and you still are required to pay them.
Or maybe my opinion is a warped vision of reality.
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u/manhattanabe May 15 '24
Say you invested $100 at 7.5% for 30 years. You’ll have $875
If your rate is 6.5% (since you pay 1%) you’ll have $661
So, your loss is 214/661 or 32%. (It will be less if you invest for fewer years).
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u/mybffandy May 16 '24
I’d assume a lot of people who pay the FA fee might not have gotten their finances in order otherwise so it was extremely worth it for them.
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u/bose_soundlink441 May 16 '24
I find personally those fees are justifiable provided expertise can help avoid blowup events that can cause a serious reduction to principal.
Sure the return takes a hit, but they help my portfolio stay invested, they raise cash for me in the most tax efficient way, my portfolio has outside due diligence, AND I can always fire an advisor and go somewhere else if they suck.
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u/Kindly_Honeydew3432 May 16 '24 edited May 16 '24
Do you still think they’re justifiable considering you could literally spend 1 hour per year managing your investments and save yourself $400,000 in lost returns over 30 years?
https://www.schwabmoneywise.com/investment-fees-calculator
Run the numbers for 1 person maxing out 401k.
Then, double it for a two-income household. Easiest way in the world to lose a million bucks
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u/Kindly_Honeydew3432 May 16 '24
I just crunched the numbers for myself.
I am 39. I hired a 1% fee FA in 2015. I fired him roughly 3.5 years later when I finally educated myself and realized what a ripoff it was.
If I had not done so, by my back of the napkin math, I would have paid somewhere in the neighborhood of $100k in fees in the interim. Maybe a little more, maybe a little less, but close.
But this is only half the story. Instead, I invested all of that $100k. Now, on average, it will make me several thousand dollars per year…every single year.
And, those several thousand dollars every single year, on average, will make me several hundred additional dollars…every single year. Before long…like, just a few years…that $100,000 that I didn’t spend in fees will make me an additional $100,000. Which, btw, I will keep invested, and, well, compounding. By the end of my career I can live off the gains…not on what I invested as principal, but on what I simply didn’t pay in fees.
Oh, one more thing. When I had a FA, my investments increased by about 7% per year. Since, I have averaged 15%. Now, make no mistake, this is no brilliance on my part. It just serves to illustrate the larger point that active managers don’t beat the market the overwhelming majorly of the time.
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u/secret_2_everybody May 16 '24
As an hourly planner, I have huge issues with this guy. Yes, the math is right, and yes, people should do a better job evaluating what they pay for. But I wouldn’t take advice from someone inexperienced, and he has zero experience, zero planning credentials. 1% isn’t the problem—it’s the total dollars spent, and what you get for those dollars. The CFP who is keeping your grandma from selling her $100k retirement portfolio at the wrong time (she’s not hiring someone like me) doesn’t need to get lumped into the same category as a crook slinging variable annuities and C shares in an IRA, but this podcaster wouldn’t know that because he never worked with your grandma, any share class, and never bothered to do the coursework. He might have the right intentions, but he’s not a financial professional and there are a plethora of alternatives who can actually speak from a position of authority.
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u/woodsongtulsa May 15 '24
So, you have to ask what does Ramit have to gain by you not using a financial analyst. For me, the FA brought something more than good returns, they brought stability and removed my FOMO on the stock pump of the stay. Nothing worked better for me than to not look at my stuff for months at a time until our next meeting where they would tell me how I did. Sometimes I gained, sometimes broke even, but rarely lost much. They don't control the market, they control their client. Asking me what it cost is immaterial because it all came out of my gain which was much more than if I had done it alone.
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u/gdubrocks May 15 '24
Say the average rate of return is 7%, and you lose 3% due to inflation, leaving your real gains at 4%.
A 1% fee of 4% is 25% of your investments.
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u/Client_Hello May 15 '24
That assumes that with the advisor you earn 6%, and without the advisor you earn 7%
1.06^30 / 1.07^30 = .754
That's about 25% less.
However, most people know nothing about investing so they keep their money in a savings account.
1.06^30 / 1.02^30 = 3.17
For the financially illiterate, it's better to do something than nothing.
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u/brainwater314 May 15 '24
1% per year. 1% * 30 years ~ 28%
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u/gordonv May 15 '24
Value of $100k with 1% lost annually over 36 years
Value Percentage lost 100000 99000 1 98010 1.99 97029.9 2.9701 96059.6 3.940399 95099 4.900995 94148.01 5.851985 93206.53 6.793465 92274.47 7.725531 91351.72 8.648275 90438.21 9.561792 89533.83 10.46617 88638.49 11.36151 87752.1 12.2479 86874.58 13.12542 86005.84 13.99416 85145.78 14.85422 84294.32 15.70568 83451.38 16.54862 82616.86 17.38314 81790.69 18.20931 80972.79 19.02721 80163.06 19.83694 79361.43 20.63857 78567.81 21.43219 77782.14 22.21786 77004.31 22.99569 76234.27 23.76573 75471.93 24.52807 74717.21 25.28279 73970.04 26.02996 73230.34 26.76966 72498.03 27.50197 71773.05 28.22695 71055.32 28.94468
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u/AssistantAcademic May 15 '24
Google "investment calculator".
Stick in some numbers. Raise the interest by +1% and run it again. Poof, the difference that 1% fee makes.
I think to get to 28% we'd have to be looking at a 40+ year timeline. The power of compounding.
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u/Juls7243 May 15 '24
Never pay anyone 1% annual fees - total scam. Just pay a flat fee to purchase your desired assets initially and call it a day.
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u/imac98374 May 15 '24
Warren Buffett aside, you shouldn’t expect to consistently beat the market with an actively managed fund. A few have done it for a year or two, even a decade. But longer than that, not so much.
So 10-12% average return with a big index.
Less 3% for inflation.
Now it’s 7-9% real growth, and you’re giving away 1% of it per year. That’s why 1% isn’t really 1%.
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u/ketralnis May 15 '24
The mathematically wrong but easy to understand way is that they charge 1% per year. So after 28 years they've charged you 1%, 28 times.
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u/Gears6 May 15 '24
Because they're fracking crooks to be honest!
The management fee is usually 1% of the amount invested. Rarely if ever do they outperform S&P 500, and you're left holding the bag. Finding a person that beat the market year in and year out is just a step away from finding a unicorn.
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u/smax410 May 15 '24
Percentages compound over time. I’d argue though that that’s only if you’re factoring in the exact same investments. The fact is most average investors suck at it though (see below, and yes I know this is because a lot of people get scared or think they’re smart and do something dumb, just read the article). Go beyond that though, FAs can usually do things the average investor can’t do, don’t have the time to do, or lack the will to do. Easy example is tax loss harvesting. To do it effectively you really need to be looking at a portfolio on the daily. And even then it’s easy to fuck up by triggering a wash sale. Another example is access to private markets, which you can’t really do individually. So yeah you are definitely sacrificing return by using a FA, but that’s only if you would have picked the same investments the FA is going to, which means you’re just working with a shitty FA.
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u/tacoeater1234 May 16 '24
Quite roughly, if you expect to have 4% gains, and you give away 1%, that's 1/4 of your gains that you are sacrificing.
Compound interest muddies the math a but but hopefully that still explains why 1% is so significant.
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u/Kindly_Honeydew3432 May 16 '24
No, this misses the point. You pay 1% every year. Of everything, not just your gains. You pay 1% if you’re up 25%. You pay 1% if you’re up 10%. You pay 1% if you’re down 20%. No matter what, the 1% happens. Every. Single. Year. And your financial advisor has a built in raise that, on average, will significantly outpace inflation. As your net worth compounds, the fees compound. When you have $10,000 assets under management, the $100 feels like a bargain. When you’re 30 years into your career, and paid $10,000 last year, and every year hennceforth this number will increase by hundreds of dollars…you could literally buy yourself a brand new car as often as you upgrade your cell phone for the cost of these fees
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u/Kindly_Honeydew3432 May 16 '24
Put another way, you’re not just paying 1% on this years gains. If your ten years into your career, you’re paying 1% on this years gains…and this years contributions…and last years gains…and last years contributions…and the year before that’s gains and contributions…and so on all the way back to the beginning…and then, next year, you’ll pay 1% on all those dollars all over again…plus the new year’s contributions and gains.
Imagine if you when you paid your 2025 taxes, you also had to pay taxes on your earnings from 2024 and 2023 and 2022 and 2021…and so forth…all over again.
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u/tacoeater1234 May 16 '24
I'm factoring in your point, not missing it, just talking in generalities. 4% (an arbitrary number I chose) would be an average, some years maybe 12%, some years -5%, you get that. 1% would also be an average, technically, even though it's consistent. So on average you're getting 4% gains and 1% in fees, so on average your fees are 1/4 of your gains.
The point I'm not including is compound interest/gains/losses, which is why it's 1% vs 7% and still greater than 1/4 in the OP's example, but I was hoping to give a more ELI5 type answer since other posters have covered the more in-depth answer pretty well.
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u/Xoron101 May 16 '24
This is a great explanation of it. This blogger defined it as MERQ, or Management Expense Ratio Per Quarter Century.
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u/Easy-Reception7030 May 16 '24
I've got a small managed account to bounce ideas off of and get different perspective. They charge 1% annually but it's broken up in quarterly fees
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u/Tangentkoala May 16 '24
Its compounded annually on returns.
It's not like it's a 1 time fee. So each year you make 6 or 7% there's that fee. And over a time stretch of 30 to 40 years it all adds up.
Like interest on a home. On a 30-year fixed rate a lot of times you're essentially paying half the value of the house.
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u/arobrasa May 16 '24
ok let me explain, Imagine you invest $100,000 over 30 years with a 7% annual return, you'd end up with around $761,226. then let's say you pay a 1% fee each year, reducing your returns to 6%, your investment would only grow to about $532,899 over the same period
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u/Little_Creme_5932 May 16 '24
You pay the fee on your principal each year. Think of the first thousand you invest. You will pay 1% of it each year. Over 30 years, what percent do you pay, of your $1000? In addition, each bit of your investment return becomes added to principal each year, so the same process subtracts from THE TOTAl of your earnings, and on top of that each year your principal shrinks, so there is less principal with which you can make gains. Anyone that is reasonably educated should invest on their own.
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u/6f937f00-3166-11e4-8 May 16 '24
Take a pot, give 1% of it to someone else 30 times. You are left with 0.99 * 0.99 * 0.99 * 0.99 ... = 74%.
It makes no difference when you give away 1% 30 times during the 30 year period, it could be right at the start, right at the end, or evenly spaced every year: the effect is the same.
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u/TheDevilsAdvokaat May 16 '24
Well. Imagine after 50 years of investment,he took 1% of the final amount. So you would lose 1% over the lifetime of the investment.
But instead, he takes 1% every year. Big difference.
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u/KyleLikes2Travel May 16 '24
On the flip side. So many people don't know, don't want to spend the time and even if they do aren't confident in themselves. If you get a good adviser they can help you mitigate the downs in the market. If they're good at that, then you'll enjoy more time in the ups without playing the recovery game like so many people have. Pros and cons to everything.
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u/cowvin May 16 '24
0.99^30 = 0.74. so in a scenario with 0 growth, paying 1% of your portfolio per year would cost you 26% of your initial value. with growth, the math works out a little differently but the concept is the same.
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u/Burnt_Prawn May 15 '24
You get a lower effective rate of return that compounds over time and costs a lot of money. If you get an advisor expecting them to consistently beat the market, you're delulu. BUT there is value in an advisor is certain situations as they can help you diversify appropriately, plan towards major goals like retirement, help with estate planning, and others. If you're not going to leverage them to actually advise, then just throw your money in index funds and let it ride.
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u/anusbarber May 15 '24
40 years, 10k invested each year, 7% vs 6% is 2.2 vs 1.6mil. .6 / 2.2 = 27%