Dear Pete: I read your recent column about adviser's fees, and I wanted to run my situation by you. We have a retirement portfolio in excess of $2M. Our financial adviser charges a $1,800 annual flat fee. The portfolio has grown in the past two years over 20% with income over $100K a year. Using those numbers, our adviser fee seems far less than your article portrays as the standard. What is the difference between an adviser who charges 0.5% of the account versus charging a fixed fee? — Kathy
Your financial adviser just sided with investors in one of the most heated debates in the investment management world — why does managing $2 million cost more than managing $200,000?
Your adviser believes the time and effort he puts into managing your money is the same time and effort that he puts into managing any amount of money. Therefore, he charges you a flat rate for his time. This actually is a rarity in the industry.
It’s the question many investors wonder about and very few ask: If an adviser spends 10 hours a year managing my money, why does the cost of their work time change based on the amount of money I have?
The shoe-shine guy at the airport gets $6, whether he’s taking five minutes to shine a pair of $40 shoes or $400 shoes. Your attorney charges you $200 an hour to read a contract worth $2,000, just as she would for a contract worth $20,000. The U.S. Postal Services charges 49 cents to deliver a birthday card with a $20 bill tucked inside and 49 cents to deliver an anniversary card with a handmade coupon for a free foot rub.
I'll admit that it isn't a total apples-to-apples comparison I'm making here and the duties involved are different.
But let’s look at what an investment adviser does. According to the Securities and Exchange Commission website, an investment adviser gives a client advice about investments. Fortunately for anyone who has ever paid a fee, a financial adviser does quite a bit more than that. A great adviser will help you evaluate your risk tolerance, your time horizon, your investment knowledge, your tax situation, your family considerations and your objective. And that’s just the start. They must evaluate investments, rebalance your portfolio, tax-loss harvest your portfolio and replace underperforming investments. That’s a lot of work.
It does still beg the question though — if your adviser does all that work for a $200,000 portfolio, do they do 10 times the amount of work for a $2 million portfolio?
Here’s a harsh reality: Advisers who charge flat fees significantly under-earn advisers who base their fees on the classic "Assets Under Management" model (which charges a percentage of the portfolio). They also can’t afford the same number of support staff and client service professionals to tend to a client’s service needs. Arguably, flat-fee advisers can’t afford subscriptions to the latest and greatest investment analysis tools either.
And investment advisers often place their clients in similar portfolios so they don’t have to reinvent the wheel every time they review the investments. It’s smart. It makes sense. It also means they aren’t spending hours and hours on your portfolio alone.
Instead of charging you $10,000 a year, which would be a standard(ish) 0.5% fee on your $2 million portfolio, your adviser is charging you the equivalent of 0.09% on your current portfolio value. And when your portfolio increases to $2.5 million, your fee will likely still be $1,800, thus the equivalent rate falls to 0.072% on your money.
I don’t believe advisers who avoid the flat fee model are doing anything wrong. And as long as the vast majority of investors have no problem with the fee model, it will stay the same.
But the next time you talk to your adviser, politely and respectfully ask them how many hours they spend on your portfolio a year, and ask them if the number of hours they cite will change when they increase the value of your portfolio over time. Email me their answers as I'm curious what response you get.
Peter Dunn is an author, speaker and radio host, and he has a free podcast: "Million Dollar Plan." Have a question about money for Pete the Planner? Email him at AskPete@petetheplanner.com. The views and opinions expressed in this column are the author’s and do not necessarily reflect those of USA TODAY.