No subject is more fraught with controversy and confusion than fees charged by advisors. Let’s look at fees in context.
Why fees are important
All costs reduce expected returns. You should be concerned about the total costs you’re paying.
Here’s a fact: According to a study by Morningstar, In every single time period and data point tested, low-cost funds beat high-cost funds.
The Morningstar study wasn’t referring to fees charged by advisors. It focused on management fees charged by actively managed mutual funds (where the fund manager attempts to beat a risk-adjusted benchmark).
But the conclusion of the study is highly relevant to your evaluation of advisor’s fees.
When higher fees may be better value
Assume you are interviewing two advisors. One charges an advisory fee of 1.25% and the other charges only 1.00%. Clearly, the second advisor is less expensive. But you need to probe further.
If the second advisor recommends actively managed funds with an average management fee (called an “expense ratio”) of 0.75%, and the first one recommends passively managed funds with an average management fee of 0.30%, you have immediately saved 0.45% every year with the first advisor. If all you considered was the quoted advisory fee and the difference in expense ratios of the investments recommended by each advisor, then the first advisor is “less expensive” than the second, even though her quoted fee is higher.
Here’s more information relevant to your decision.
Difference in expected returns
According to reports prepared by Standard & Poors (called the “SPIVA Reports”), over the long-term (10 and 15 years), at least 80% of active managers underperformed their respective benchmarks across all domestic equity categories.
The more expensive actively managed funds recommended by the less expensive advisor are likely to underperform the lower cost funds recommended by the more expensive advisor. This difference in performance, if it occurs, would be an additional cost.
Difference in services and standard of care
You also want to compare the total services offered by both advisors. Do they both:
- Do comprehensive financial planning, in addition to managing your investments?
- Engage in tax-efficient planning for your investments, your withdrawals and all aspects of your retirement planning?
- Agree in writing to disclose all conflicts of interest and to always put your interest above theirs?
A complicated decision
Don’t view fees in a vacuum. Before you make the most important financial decision in your life, understand that an advisor’s fee is the first step in your analysis, not the last.