There is a real battle on right now for new clients for financial advisors – the battleground is at the Generation XY level. Let’s bust through some of the bullshit, and discover who actually needs an advisor, and what fees are really worth.
Firstly, we need to acknowledge that everyone is playing around with the benchmark in order to appear to offer better value. In order to show how valuable they are to you they opt to compare themselves with Mutual Funds, or with “high fee” advisors. Show me a benchmark where these new firms put themselves up against a simple ETF strategy and it would be a very different picture painted.Now, don’t get me wrong, there are still slimeballs selling heavily loaded Mutual Funds to the oblivious, so educating people about cheaper options is still required, and what’s more, there is nothing wrong with paying good money for good advice. But what are you really paying for, and how much are you really paying?
There are two real camps to look at in this battle – the Robo Advisor and the Gen XY Planner. On the subject of Robo Advisors – my take on them is that they are very viable investment solutions, but they very much are NOT an Advisor, because they look only at your asset allocation, not holistic goals. Proper Financial Planning factor in many diverse subjects, including:
- Tax Strategy
- College Savings
- Retirement Planning
- Employee Benefits
- Trusts and Estates
As an Advisor, you might be on call to help a client decide whether they should pick between investing $20,000 in a fund or paying off a car loan. You might discuss how much to allocate into retirement vs into a 529 plan, you might discuss the virtues of paying down a mortgage early vs buying an investment property for cash flows.
In some ways a Robo Advisor might offer more sophisticated allocations, however this only occurs within a very narrow set of parameters. They are best compared with a target date fund, such as offered by Vanguard.
So when do you need a Robo Advisor and when do you need a Real Advisor?
You need a Robo Advisor once you have your stuff together. They are just a fund of funds. The real advisor, you pretty much need from middle school onwards, as there is a desperate lack of financial education in the US. However, both are parasitic, and if you engage them at the wrong time you’ll take longer to reach your goal.
Real Advisors come in two forms, Fee Only, or Commission Based (including Fee Based) a Fee Only Advisor/Planner is compensated only by the client, whereas the Commission based Advisor is compensated by third parties. This compensation method creates a conflict of interest and advice cannot be considered truly impartial. However, Fee Only Advisors are getting up to mischief too, and it is highlighted in the XY age bracket. By mischief, I don’t mean anything illegal, but I would propose that they are charging too much.
Fee Only advice is worth it!
I am not for a moment suggesting that Fee Only Advisors are charging too much for what their knowledge is worth. Most Fee Only Advisors are highly trained professionals, however, I think we should consider how much the advice is worth in relation to cost. Let’s recap: a Robo Advisor offers zero advice for its 0.25% fee, but can offer investment upside over more expensive funds. Real advisors can help you decide on paying down your mortgage vs opening a hot dog stand, or creating an estate plan that will protect your assets from excessive taxation. But you are talking about a customer with little to no wealth here!
When we go back to the original argument about excessive fees, let’s consider the worst of the worst, some horrible dinosaur who somehow manages to sell you front loaded funds (5.75% upfront penalty), within a 1.5% AUM managed account.
That’s horrendous right?
Let’s say Bob has $10,000 to invest, in your first year he is sold the ‘fund du jour’ for the full amount. On day 1 his wealth drops to $9,425 because of that load fee, and then, assuming no appreciation he has to pay out another $141.38 in AUM fees for the year. This really is one of the worst case ‘advisor’ situations, and his total cost on investing his money is $716.38 for the year.
If you saw that happen you’d (hopefully) slap some sense into the guy and send him to a Fee Only Planner.
The problem is that Bob only has $10,000 to invest, because he is just starting out in life…. the line you get from the Fee Only Planner is something like:
‘We aren’t like your parents’ advisor, we make planning affordable’.
I often see
‘firms charging AUM fees of up to 1.5%, which on 1M is $15,000 per year, we think this is unfair, so charge a simple, affordable monthly fee.’
Interestingly, the monthly retainer for the XY focused firms often starts out with a bump, then runs at about $100-200 per month. The initial bump is to ensure that if they build a comprehensive financial plan you don’t run off and leave them having paid just 1 month of money. If we take the lower end of this we could be looking at $500-$1500 for the plan, followed by the monthly retainer, at best that makes it $1700 per year.
So, should Bob go with the sleazeball selling him front loaded funds, and pay out 7.16% in year one (1.5% subsequent years) or should he pay 17% in year one, and 12% subsequent years? The fact of the matter is that Bob might well need some financial education, but if he is paying 17% (or more) per year to get it then he is never going to be able to achieve his goals.
I think this battle of the XY market is being quite unfair to them as clients, unfortunately Robo Advisors are capitalizing on this and marketing themselves as a solution, but they don’t actually offer anything other than an investment vehicle. Having said that, it might well be that until you reach a certain tipping point in terms of wealth you don’t need anything more than an efficient investment vehicle.
The emergence of the hourly fee or monthly retained advisor has piggybacked onto the Fee Only pricing model, and in doing so has allowed them to charge fees that are disproportionately high, I’d suggest if you think you are ready for a financial planner you do some simple math first:
- Add up all of your assets.
- Deduct from this your liabilities
- Divide into this the total first year fees of your planner/advisor.
If your fees are anything above 1-1.5% then you should ask yourself is the advice really ‘worth it’ now. For some it may be, for example, a young Doctor or Lawyer may have a negative net worth due to student loans, but a large cash flow from their new salary. For such a case the monthly cost of retaining a skilled professional is negligible.
You have to bootstrap your finances
If you are starting out in life financially you can’t afford to toss money away, even for good advice. Advisors can tell you how to structure your wealth, but if you don’t have any the impact and savings of doing so are outweighed by the cost of their time. While the advice from Fee Only planner is often excellent, so is a hotel room in the Four Seasons, but that doesn’t mean you should live in the hotel 365 days a year rather than rent or buy your own place. If you want to get to the point where you can afford to offload your financial decisions, and structure your future, you need to put the effort into learning.
I’d suggest joining Bogleheads.org it is a forum that focuses on low cost index investing, or come along to the Saverocity Finance Forums to explore aspects of your finances that you want to learn more about, and once you are in good standing, consider bringing in a fee only planner to take the workload from you.