Posted by: Thomas F. McKeon, CFA on March 4, 2020
Clients earn returns net of fees—the incontestable truth.
“Where Are the Customer’s Yachts?”
Despite the lush equity market returns of 2019, a broadly diversified and globally allocated (60% stocks-40%bonds) portfolio has only earned an average annual return for the past five years of roughly 6.5%, before expenses. That return comes from a simple three benchmark index we maintain and use in client reports. The three benchmarks are 30% MSCI US Broad Market, 30% MSCI World ex US, and 40% US Aggregate Bond. That same benchmark only earned an annual average of 3.8% for the five-year period ending 12-31-2018. The point is just that 2019 notwithstanding, market returns have been quite modest.
Competition is Fierce
As an independent Registered Investment Advisor (RIA) we operate in a highly diverse and competitive environment. We compete for business with other independent RIA’s, national RIA’s, wirehouse brokers (Merrill Lynch, Wells Fargo, etc.), regional brokers (Raymond James, Stifel, Edward Jones etc.), independent brokers, discount brokers, financial planners, insurance agents, mutual fund companies, local bank and trust companies, turnkey asset management platforms (TAMPs) and more. Any and all of them would offer you a product or service to address your investment needs. And all of those products and services will provide you a result. The critical question is however: will that result be optimal...in terms of outcome, risk and costs?
Every investment business that is licensed and operates as a Registered Investment Advisor must file and annually update their form ADV with the appropriate regulatory agency—the SEC or state agency. All of these Form ADVs are available to anyone for free from the SEC website. It is available in the interest of transparency and full disclosure. This form details: methods of business, investment services, professional education, disciplinary infractions and fees, among other items.
Yet (Most) Advisor Fees Remain Stubbornly High
We look at a whole lot of ADVs in an effort to understand how we at Clothier Springs Capital Management are positioned against the various investment programs and fee structures offered in the RIA world.
The overwhelming majority of RIA’s we examine have an annual asset-based fee of anywhere from 1.0% to 2.0% with the bulk coming in around 1.25% to 1.5%. For a portfolio earning a total return before fees of the aforementioned globally balanced benchmark of 6.5%, the net return to the client is: 5.25% (6.5% - 1.25%). The advisor has snatched almost 20% of your return. For a fee of 1.5% the advisor has snatched 23% of your return. This of course matters tremendously in the long-term compounding of your returns.
A 1.5% Fee Is NOT, REPEAT NOT an RIA’s Birthright
In routinely surveying the RIA landscape it is obvious that most of them believe that it is their birthright to levy a 1.0% to 2.0% asset-based fee on client accounts….some quite a bit more. And don’t get me started on the “twofer of terribleness”—hedge funds and funds of funds.
Here is why that matters.
In Investing You Get What You Don’t Pay For
If you pay more for a car you will probably get a better vehicle: safer, more luxurious, more bells and whistles, etc. If you pay more for a guitar you will probably get an instrument that is better: more playable, more durable, truer construction, better materials, better tone, etc. You get the point.
The inverse is true for investments for the simple fact that clients earn net returns after fees. You pay more—you get less. In investing, you get what you don’t pay for…to paraphrase Jack Bogle, the venerable founder of Vanguard. This simple truth is why Vanguard now supervises $6 trillion—trillion with a t—of client assets
A $1 million dollar portfolio will be $160,983 smaller than it should be after ten years if it is being charged an annual fee of 1.5% instead of 0.5%. That is your money and it is being captured by your advisor.
Now most of the folks charging those lavish fees try to justify them with tales of better returns or ancillary services. The reality is that excess returns rarely materialize…and when they do, it is the advisor that captures the excess returns through the fat fees.
This brief essay does not consider the other charges that are often embedded in the cost structure—depending on the vendor: internal fund fees, brokerage commissions, insurance charges, etc. All of these will further degrade returns.
1.5% = 23% of 6.5%
In the abstract, a 1.5% asset-based fee may not sound like much, but it in this market environment it degrades the net return of a globally balanced portfolio by almost 25%. In those terms, 1.5% is more like extortion…tantamount to a straight transfer of client wealth to advisors.
Of course, every business has to cover its costs or it will not long exist. Yet the investment industry is not a capital intensive business: no factories, warehouses, or other extreme capital requirements. Much of the revenue turns into advisor compensation.
Where Are the Client’s Beach Houses?
Fred Schwed wrote a book in 1940 about the self-serving lunacy of Wall Street. The famous quote “Where are the customer’s yachts?” is the retort in the Peter Arno cartoon from the passenger in a car being shown the yachts of Wall Street magnates.
From a review of the re-release of the book in 1995:
“It’s amazing how well Schwed’s book is holding up after fifty-five years. About the only thing that’s changed on Wall Street is that computers have replaced pencils and graph paper. Otherwise, the basics are the same. The investor’s need to believe somebody is matched by the financial advisor’s need to make a nice living. If one of them has to be disappointed, it’s bound to be the former.”
John Rothchild, Author, A Fool and His Money,
Financial Columnist, Time magazine
It Is Difficult to Get A Man to Understand Something When His Salary Depends Upon His Not Understanding It
Technology and scale are combining to drive costs out of the investment business. Zero commission trades are not uncommon. ETFs and index funds have expense ratios so low they are inconsequential. Yet investment advisors in the main still think they are entitled to an annual asset-based fee of 1.0% to 2.0%.
We live in the information age. Any client could inform themselves and understand how much their advisor’s compensation is costing them. It is a mystery to us why so much client money languishes in accounts with advisors who charge so much. But perhaps the quote in the book review above says it all. Maybe investors just need to believe in somebody not so interested in feathering his own nest. And the only way to quantify that is by understanding their fee schedule and the impact on returns.
How much of your return is your advisor snatching?