The Impact of Paying a 1% Advisory Fee
If we’ve said it once, we've said it a hundred times - costs matter! To echo the words of the legendary John Bogle (or “St. Jack” as we like to call him), “In investing, you get what you don’t pay for.” While many advisors pay lip service to this idea and (to their credit) avoid high-cost investment options, they seem to conveniently forget that their own fees are just as much of a detriment to their clients’ well-being.
According to AdvisoryHQ, the average annual advisor fee for an investment amount of $1,000,000 is about 1.02%, based on a 2017 sampling of government filings of registered investment advisors and asset management firms. For the sake of simplicity, we’ll call it 1%. To most of us, 1% sounds like practically nothing, especially when compared to Class A mutual fund shares that charge a front-end load of 5% or more. However, unlike the load which is paid once, the 1% fee is paid year-after-year.
The long-term impact of a 1% fee is difficult to discern through intuition alone. We really need some good old-fashioned number crunching, so here it is:
Ending Value of a $1,000,000 Investment that Earns 7% After 30 Years
No Fee (7.0% Annual Return) = $7.61 million
1.0% Fee (6.0% Annual Return) = $5.74 million
To summarize, the seemingly innocuous 1% fee causes a $1.87 million (or 25%) reduction in the ending value. As Boston University securities-law professor Tamar Frankel said in Jason Zweig’s Wall Street Journal column of 4/1/2016, “A fiduciary doesn’t have to be Mother Teresa.” True! And some advisory fees (those north of 2%, for example) seem more reminiscent of Ma Barker.
Undoubtedly, we will hear the clamor and din of financial advisors proclaiming that their services beyond investment management are easily worth $10,000 per year to their $1 million clients. These services such as financial planning, however, can usually be performed on either an hourly or a flat annual fee basis at a far lower cost.
The other average advisory fees found by AdvisoryHQ are also quite instructive. A $2,000,000 investment comes in at 0.91% (or $18,200 annually), while a $5,000,000 client is charged 0.84% (or $42,000 annually). Well, that’s practically enough to hire an assistant to do nothing other than looking after that account. Remember, these are average fees, which means that quite a few clients are paying even more.
It is important to note that, in contrast to “fee-only” advisors, “fee-based” advisors may act as a fiduciary with respect to investments while selling their clients expensive insurance products such as variable annuities that pay them a hefty commission. Hiring a knowledgeable and proficient advisor who agrees to always act as your fiduciary is an important first step on the road to financial security. However, that alone is not enough. Smart clients will ascertain exactly how they are being charged and assess the impact of fees on their long-term expected growth of wealth.