Last week, New York City officials were shocked to learn they’d spent over $2.5 billion on pension fund management fees over the past decade.[i] They are probably not the only ones who would have sticker shock: According to a new North American Securities Administrators Association (NASAA) survey, one-third of US investors don’t know how much they pay for money management. Older studies suggest up to half say they don’t know or—frighteningly—think they pay zilch. Folks, public service announcement: You can’t know whether you’re receiving good value from an investment manager unless you know how much you’re paying. Though, a full cost/benefit analysis isn’t quite so simple as comparing fees and returns, despite what some suggest—qualitative factors matter, too.
The performance aspect does matter, of course. Fees can be high for some investment vehicles versus other lower-cost options, and the difference can add up over time. Variable annuities, for example, pile fees on top of fees. Paying for multiple layers of management—like paying an adviser or broker to select funds for you, and then paying fund management costs—can erode returns and stymie progress toward your long-term goals. Understanding who you’re paying and how they’re paid can help you eliminate some perhaps unnecessary drag. Money paid in fees is money that isn’t compounding for you (hence why ensuring you receive performance reports net of fees, not gross, is paramount).
However, in some cases, fees’ impact on returns is not the be-all, end-all. For mutual funds, sure—performance is all you’re paying for, as they don’t provide service, and you’ve presumably done the hard work of picking an asset allocation to reach your long-term goals. But if you’re working with an adviser, service is a big piece of the package. And by service, we don’t just mean helping with operational matters or sending the odd research report (though those are nice)—we mean all the things an adviser does to help ensure you, the investor, get and stay on track to reach your long-term goals.
Getting you in the right strategy is step one. An adviser who takes the time to get to know you, understand your goals, identify your investment time horizon, learn your needs and personal circumstances—and then develop a sound plan that targets the long-term returns likeliest to meet your goals—is performing a big, life-impacting service right out of the gate. Having a suboptimal investment strategy can be the road to heartache in the long run. Someone who tries to account for all your needs, rather than plopping you into a static stock/bond mix based on your age or a risk-tolerance survey alone, often adds value you can’t immediately quantify. It takes a very long-term perspective to fathom the benefits of having the right asset allocation.
Receiving those benefits also requires sticking with a sound strategy, which is easier said than done. Often, investors’ biggest obstacle to long-term success is themselves. Fear and greed prompt folks to buy and sell at the wrong times. You can see this in studies from DALBAR, Morningstar and others showing investors flip in and out of funds often, with trading activity spiking when markets are volatile. Daily ETF flows show this, too. Humans are ultra-prone to making emotional decisions based on fear, greed and other faulty inputs. Fear makes folks sell after short-term drops, thinking it stops the bleeding; react to scary, sensationalist headlines; and run for the hills at the first sign of iffy economic data. Greed makes people go hog-wild for the latest hot performer—chase heat—or throw risk management to the wind late in bull markets, seduced by a seemingly unstoppable rally.
Good advisers can help you keep these impulses in check, helping you avoid trading on past performance or other backward-looking factors. By providing regular advice and counsel, they can help you distinguish useful news from noise and be your safeguard against behavioral errors. The latter is rarer than you might think. The investment world is full of yes-men, who enable pitfalls in a vain effort to make clients happy right then, instead of helping them see the harmful impulses for what they are. Investors who went cuckoo for Cocoa Puffs over dot-com IPOs in late 1999 didn’t need an enabler—they a needed tough-love reality check and reminder that profits, not clicks, are required for a sustainable business. Similarly, folks who wanted to ditch stocks and load up on gold in March 2009 most needed a gentle reminder that gold is no safe haven and stocks rebound hugely off bear market bottoms. What they didn’t need: a yes-man serving up their choice of shiny gold ETFs. Or offering to swap their broad equity funds for narrow tactics aiming to profit from further downside.
Advisers can also add value by being a reliable consultant. Like helping prevent you from falling for unconventional, too-good-to-be-true investment strategies. You know, the kind that boasts and promises exceptionally or consistently good (guaranteed) returns, regardless of market conditions. Probably using some complex-sounding flashy tactic, promising that if you just turn your hard-earned wealth over to their care and custody, they’ll magically multiply it for you. Such gimmicks are often the road to financial ruin—a good adviser who isn’t tempted by the snazzy marketing spin can help you be more discerning and tell you what questions to ask to ferret out any potential funny business and avoid being a statistic.
Unlike the impact of fees on net returns, the value of you-first investment advice is difficult to quantify—but easy to qualify. Consider: Have you ever wanted to do any of the above, or similar? Has your adviser told you what you didn’t want to hear at the time but later realized you needed to hear? Can you guesstimate how you’ve done versus how you might have done if you’d followed your own lead? If your adviser steered you away from something too good to be true, have you ever Googled to see what happened to that shiny alternative?
So, how can you determine which advisers provide value-adding service? We recommend asking questions. We’ll leave you with a few:
- Do you separate sales from client service? A dedicated service person or team is likely incentivized to focus on you and take the time to give you specialized advice. If they have to wear multiple hats and spend time prospecting, that takes away from service.
- What is your investment philosophy? Managers with guiding principles will often be more disciplined.
- What would make you recommend a deviation from my portfolio’s long term allocation? If the answer is something other than “a change in your goals, needs or time horizon” or “a radical shift in our market outlook,” more questions are warranted.
- How are you compensated? Incentives matter!
- Do you sell proprietary products or securities from your own inventory? This, too, could incentivize suboptimal recommendations.
- What drives recommendations? Beware of Wall Street mythology.
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[i] The $2.5 billion they quote isn’t quite right. It is actually the amount by which net-of-fees returns trailed gross-of-fees returns over a decade. That is part actual fees paid and part compounded opportunity cost. But $2.5 billion sounds way splashier, and details are for nerds like us, we guess.