How to Minimize Investment Returns, The Rest of the Story

In the previous posting we discussed the ridiculous layering of fees that has occurred in the investment industry. Just what one is paying for, is often disguised through a lack of transparency, accountability and general knowledge. Most advisors, provide pretty financial plans for a fee, charge an asset management fee, broker the investment making to a third party for still another fee, and then use the financial plan to sell insurance products for, you guessed it, more fees. Despite the inherent potential conflict of interest with this model, I always find it amusing that nearly every advisor I have come across, holds themselves out as, “independent” and “objective.” For reasons that may not be obvious to someone with integrity, the law rightfully doesn’t allow for investment advisors to be compensated solely based on the growth of a client’s assets. With that in mind, it is the customers (unfortunate) responsibility to find an advisor who is truly independent and who’s only compensation is as objective as possible (ie. A fee based only on the assets under management). This contrasts with the conflicted incentives an advisor can receive for selling commission based products.

It is true; some commission based products can be beneficial. It remains however, that the true cost of these products is not clearly transparent in many cases. Further, the investment may not remain in a portfolio long enough to benefit the investor, nor does it allow for flexibility in making changes to the portfolio, as is the case with most loaded mutual funds [a mutual fund where a commission or sales charge is paid at the time of purchase (front-end load), when the shares are sold (back-end load), or as long as the fund is held by the investor (level-load)]1.

For my money, I expect the advisor to do what they are paid to do, that is, manage the investments. Too often, an advisor hires someone else (a mutual fund manager or separate account manager) to actually invest the money. Then if the manager doesn’t do well, it’s not the advisor’s fault; the advisor will sell the fund and move the money into a new fund (potentially receiving a commission, if it is a load fund). It is amazing how advisors can escape responsibility, despite the fees they are receiving for “managing” the investments.

Typical Fee structure for the entire aspect of a broker/advisory relationship:

Advisory fee (1.0%) + Brokerage/Admin fees (0.2%) + Manager fee (1.0%) = Total 2.20%. This total (2.20%) does not include agency costs or commissions, both of which raise a conflict of interest question. With load funds, this total can easily eclipse 3.0% when commissions are amortized over the investor’s life in the fund.

Typical Fee structure for an Independent fee-only Registered Investment Advisor (RIA), who also performs money management services:

Advisory fee (1.0%) + Brokerage/Admin fees (0.25%) = Total 1.25%. As you can see, this model affords the advisor a nearly 1.0% advantage in maximizing after-tax returns. To illustrate the importance of this difference, we have created a quick calculation. Let’s take a $1,000,000 portfolio and for sake of this argument, assume a 7% return per year. What is the difference between the two above mentioned scenarios:


Substantial, don’t you think?

At it’s worst, working with an investment broker/advisor can unknowingly erode a portfolio and/or handicap returns.

At it’s best, working with an independent fee-only RIA, should be an incredibly rewarding experience. They should always put your interests first, accept no compensation that would impair their ability to give unbiased advice, be honest and transparent, invest in a manner consistent with their own personal portfolios, keep a long-term perspective, and remain vigilant about minimizing fund expenses, transaction costs, and taxes. Unfortunately, we have found the aforementioned all too lacking in our industry.