Despite my enthusiasm for do-it-yourself investing, I understand that most people need help. The problem is that far too many investors who seek help end up just being sold expensive mutual funds. This got me thinking about what is the minimum that investors need to do for themselves; what one thing can they not afford to leave to their advisors? Here is my suggestion:
All investors should be able to work out for themselves how many dollars they pay per year in fees across their portfolios, including management expense ratio (MER) costs, fund loads, commissions, and any other costs.
Instead of focusing on the “top ten things to look for in a financial advisor,” investors would do well to learn enough to be able to protect themselves from bad advisors and recognize good advisors. I think the knowledge required to add up portfolio costs is a great starting point for learning how to evaluate advisors.
Reasonable financial advisors should be able to help their clients understand how to add up costs. Investors who don’t know what they pay in fees and don’t know how to work it out for themselves have no idea if they are being taken for a ride or not.
I’ve been told by several people that they have a “great financial guy,” but many of these people aren’t even aware that this great financial guy gets paid out of their savings. Instead, these people should be able to say “I paid $2850 in total portfolio costs last year and the service I got for this money was worth it.”
No doubt we could all come up with a lengthy list of things people should understand about investing, but given that so many investors start with so little knowledge, I recommend learning how to identify costs as a starting point. I’m open to opinions on other starting points, but I’m not interested in making a list. If there is something better than my suggestion, then let’s replace it rather than add to it.
I'll just say that value for money is important for any service, that's just my thinking. I will gladly pay more for something if I feel it's worth the cost; if there is a direct benefit to be had.
ReplyDeleteFor some people, I suspect they just don't care or think about that as much?
Good post Michael.
Mark
Your recommendation shortened to one sentence should be used as an epigraph to any financial course or book. EVERY investor must be able to say: "I pay xx to earn yy."
ReplyDeleteVery, very wise.
I love how you approach this. Understanding (as AnatoliN says) "I pay xx to earn yy" is basically explaining the rules of the game.
ReplyDeleteYou are so right, everyone wants a top 10 list of what to look for in an advisor, without having a clue how much they are paying in fees.
@Jackson: We're up to 4 of us with the same mind on this one.
Delete@Mark and @AnatoliN: It sounds like we're in agreement. So now if I listen to someone rave about their financial guy but don't know how much they pay, I'll say that they have no real idea if the financial guy is good or not.
ReplyDeleteYou hit the nail on the head with this post Michael! I cringe whenever one of my co-workers mentions just how great their ‘advisor’ is.
ReplyDeleteAs for whether the average investor doesn’t care, or doesn’t think about it; I believe they just don’t know any better because they believe the ‘creative truths’ their advisor has told them.
If AnatoliN’s equation was put in a nice, big, bold font at the top of all investment statements, I bet people would quickly wise up as to how expensive their great ‘advisor’ truly is!
@Anonymous: I can just imagine a follow-up conversation after your co-worker mentions how great their advisor is:
DeleteYou: How much do you pay in fees each year and is the service you get worth the money?
Co-worker: Uh, I'm not sure.
You: Then you don't really know if your advisor is any good.
Co-worker: [fume]
"I pay xx to earn yy" is basically explaining the rules of the game... well sort of. Unfortunately it does not address the comfort level of the investor. Earning yy is not guaranteed, so somehow there needs to be an extra variable in the statement to account for the reliability of the return too I would think. Nothings ever simple. - Cheers.
ReplyDeleteSo I decided to lay it out there. So for 12 month period from Aug12 to Aug13, I paid $8,500 for 9.5%. This is all fees, MERs, etc.. So does that say anything to anyone? Not sure it does... - Cheers, Phil.
DeleteI think you need to know the ever elusive question of how large is your portfolio as part of this equation to really make sense. If mine was $100K, you would all be saying, are you nuts? If it was $1M, you might be saying well done... - Cheers.
Delete@Anonymous: I agree with you that "I paid xx to earn yy" is not exactly the right way to view this. In your case, you paid $8500, but it was likely the market that delivered the 9.5%. I think you need to say that you paid $8500 and got some set of valuable services for your money.
DeleteSo I'll go one further... So for 12 month period from Aug12 to Aug13, I paid $8,500 for $67,000 of return. This is all fees, MERs, and any interest etc. The only problem with this is most believe the numbers should be kept private for some reason. If I do it this way, now someone should be able to compare... Correct? So really the ignorance of some is probably more related to pride, just like not accepting that a person may be obese. There are many ways to know how well or efficient one is doing, but as humans, if we think we don't compare, we tend to hide, or avoid the matter - Good article - Cheers.
Delete@Anonymous: Do you think that the $67,000 you made was a result of great service you got for your $8500, or is it just the market that gave you this return. In other words, do you think you got good value for your $8500?
DeleteOkay, I think I see where you are going with this, but that is not really the jist of the posting. great service... No, only because I do not have a formal advisor, so really the fees are more a cost of doing business I guess, so not the same. MERs are a good part actual expenses, and not "advice" services. It costs something to place a order, and to logistics and security for transactions. If it is the cost of advice we are trying to figure out, I'm the wrong guy, and my answer should have been $0 advice cost to make my $67K return, but rather transactional costs of $8500.
Delete@Anonymous: It was the jist of my article, but perhaps not the jist of your comment. If you're a DIY investor, then the $8500 you paid is likely some combination of MERs and commissions. If you're in actively-managed mutual funds, you can decide if the $8500 you paid got you a better return than you would have had with a simple index fund.
DeleteProbably right - I like to ramble... For me as long as my net worth grows by 8-10% each year for this point in my life, I'm happy :P. Maintaining the overall is what really guides me. - Cheers.
DeleteI think I will start calculating this for my portfolio, once every year...
ReplyDeleteI can't believe I didn't think of doing this years ago!
@Be'en: Hopefully you'll find that you're getting good value for your money.
DeleteAwesome post Michael!! Too many people are focused on chasing returns without any clue as too how much they are paying in fees.
ReplyDeleteNow I know what to say when people say they have a “great financial guy”.