Episode #116: Understanding Management Fees Paid by the Client

Many clients are immediately turned off the moment a conversation about fees is brought up, but what if over the course of your financial journey those fees actually paid off? A recent study by DALBAR found that clients investing for themselves underperformed, both in the short term and in the long term, in comparison to funds managed by registered investment advisors.

In this episode of Money Script Monday, Robert reviews how to measure the total value you can expect to receive with a full-service advisory approach compared to a DIY approach.


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Video transcription

Welcome to another episode of Money Script Monday.

My name is Robert Reaburn, and today we're going to be going over and breaking down all of the fees that you, the client, can expect to pay when utilizing the services of a full-service registered investment advisor.

The whole point of today's presentation is to really understand whether or not we, the client, are getting what we pay for.

In order to do that, we have to first understand the total fees that we're going to be expected to pay.

Then, how to measure the total value that we're getting in return. Of course, we want to make sure that total value is greater than the total fees being paid.

Full Service Advisory Approach

In order to do that, what are the total fees that the client can expect to pay over the course of their financial journey?

Full Service Advisory Approach

The first, of course, is the fee that we pay to the professional investment advisor that we hire to really accompany us on that financial journey.

The second basic fee is the fee that goes toward the investment products themselves.

When we hire an advisor, that advisor is going to put together a roadmap for us and then select certain financial products that they feel, based on the information provided by the client and where they're trying to go, that will give them the best shot at getting from point A to point B and achieving those financial objectives.

Those financial products are managed by what we call mutual fund companies and those mutual fund companies, of course, have to make money somehow.

They do that through charging a management expense ratio.

No matter what happens, it doesn't matter if you, the client, decide to hire a financial advisor or if you decide to do it yourself, you're going to pay that investment product fee.

Typically speaking, a management expense ratio is going to vary based on the type of product that you purchase and invest into.

If you decide to buy an index product, which is what we refer to as a “market access” product with no risk management whatsoever, those products are going to be on the cheaper end.

Probably below 0.5%.

If you decide to purchase and invest in a full-service active investment product, such as what we offer here at LifePro Asset Management or other products such as T. Rowe Price or some of the higher end products at Fidelity, you're probably going to pay closer to what we call a 1% management expense ratio.

On top of that, there is what we call a trading expense ratio.

Every year when we start a new year, those portfolio managers that manage those mutual funds, those ETFs, those hedge funds, they have an estimate in terms of what those trading costs are going to be, but they don't really know.

So, those trading expenses are gradually implemented throughout the year based on the level of trading activity.

Fortunately, we can ultimately judge whether or not the trading activity that's being incurred is delivering value to us based on whether or not those investment products are beating their benchmark and delivering excess return over and above the total fees that we're being charged as the client.

That's another great way that a financial advisor delivers value to you because they're in the office every day making sure that those investment products are delivering value.

You may ask the question, “the investment products are always going to charge a fee and the investment advisor is an optional fee.; sSo, why don't I just not hire an investment advisor and purchase those investment products ourselves?”

That's a great question.

At the end of the day, the reason why clients hire a financial advisor is that history has proven that financial advisors ultimately deliver a better overall investment return experience versus those clients that try to do it themselves.

So, what do you get in return when you hire an investment advisor? That investment advisor is going to provide a few things for you.

First of all, they're going to provide and construct a customized financial roadmap for you and your overall household.

To really understand where we want to get to, we have to know where we're at today.

One of the ways that we explain and illustrate what our advisors do for clients is to compare them to an Uber driver.

At the end of the day when we hire or when we use our Uber app, we punch in where we're at today and where we're trying to go.

What does that driver do? That driver gets us from point A to point B, but more importantly, they accompany us along that journey.

If there are any detours, if there's a traffic jam, as I'm sure any of us here in Southern California or off in the East coast have experienced, that driver will try to get around that traffic jam and deliver us to that destination.

That's exactly what an advisor will do for you.

As your life changes, as certain challenges arise or certain great things occur in our life, we actively change your financial plan to best fit the present scenario in terms of how our life looks today and what we're expecting going forward.

That's what we call that active asset allocation approach.

There may be times where we can afford to take a little bit more risk and swing that bat a little bit harder. Your advisor will change your plan when that happens.

There may be times where certain financial liabilities arise and we really need to get more conservative, we have to increase the amount of liquidity in our portfolios to make sure we have some extra cash on hand.

Again, your advisor will do all of that for you as part of that full-service advisory approach.

The other big thing that an advisor provides is making sure that when we're selecting those investment products, that those products themselves are executing and delivering performance to us, the client.

In other words, every single year your advisor will sit down with you and say:

"Where did we expect your plan to be after year one, after year three, after year five, etc, and are we ahead of that roadmap or are we behind that roadmap?”

“Now, if we're behind that roadmap, it's very important to understand why we are behind."

A lot of the times it's going to be because certain investment products are underperforming the market and are underperforming the mandate that we hired those products to do.

If that's the case, your financial advisor is going to be right on top of it.

What they're going to do is immediately reallocate your portfolio from those products that are not working, toward those products that are actually delivering solid excess performance.

That's really, at the end of the day, what an advisor does for you, the client, to earn that 1%.

DIY Approach

The next question you're going to ask is, “well that's great, but at the end of the day, show me the results. Do advisers, when you combine the advisor fee, the investment product, fee, trading fees, all of those fees together, do they actually deliver excess performance versus just investing directly into the market?”

What we did is we looked at a recent DALBAR study and we wanted to compare what happened when clients tried to invest for themselves when they couldn't really invest with their full attention at hand.

And what we noticed was the “do-it-yourself” approach structurally underperforms both in the short- term and in the long-term.

DIY Approach

What we see here is over a three-year time period, clients that tried to invest for themselves and not use an investment advisor underperformed the market by over 330 basis points.

In other words, that 1% that you're paying the advisor certainly looks like a bargain when we see these types of numbers.

More importantly over a 25-year time period, those clients that are actually quite diligent in saving and putting money into the market still happen to underperform annualized every single year by almost 2% versus the market.

In other words, again, that 1% seems like a bargain when we look at the structural under-performance that we see versus those clients that tried to do it themselves.

We think that based on the stats at hand, based on the results that we see every day, for clients that utilize a fiduciary financial advisor over the long run, that the 1% that our advisors charge are certainly a huge bargain over the long run.

It helps us as clients remove a lot of the emotion that we experience when we're seeing the media day-to-day, those scary headlines, and really pay attention to what we're trying to do with our financial objectives as a household over the long run.

Thank you again for all your time.

If you have any questions, please do not hesitate to contact your local financial advisor that's affiliated with us, at LifePro Asset Management.

You're always welcome to contact our offices directly here in San Diego at (888) 543-3776, and we would be more than happy to answer any questions or concerns that you may have.

Thank you again for all your business and have a great week.

The information here is presented by licensed professionals and not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstance. These videos are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable. The information presented may change at any time and without notice.
Investment advisory services offered through LifePro Asset Management, LLC, a registered investment adviser. Investments involve risk and are not guaranteed. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy will be profitable or equal any historical performance. Discussion of any specific stocks are based on objective, non-performance criteria and such discussion neither serves as a recommendation nor as the receipt of, or a substitute for, personalized advice. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current position(s) and/or recommendation(s).
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About Robert Reaburn

Robert Reaburn is the Executive Vice President and Head of Wealth Management at LifePro Asset Management. He works with financial advisors building diverse financial portfolios that best prepares their clients for their financial future and provides peace of mind.


This information is meant for educational purposes only.

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