This summer I took a trip with my best friend to Colorado to whitewater raft a few of the state’s gorgeous rivers. During the trip, our raft guide was surveying people about their careers. I of course told him I was in wealth management, and after confirming that people paid me to manage their money, he uttered “it’s amazing what people will pay people to do.”
The irony made me smile. I was paying this same guide to take me down a public “free” river that I could have gone down by myself. Had I done it alone, I would have needed to spend a solid amount of time researching, training, and practicing. I paid a fee so that I didn’t have to spend my time that way. Instead, I got to enjoy the experience. We rafted category 4 and 5 rapids with his skilled guidance. I paddled when he told me. I rested when he said it was alright. I never fell out of the boat. Maybe it is amazing what people will pay people to do, but for me, it was worth every penny.
I don’t completely disagree with my cheeky raft guide though. When I hire someone to do a job, I want to know what I’m paying and how. That isn’t always clear in the investment world.
The Wealth Management/Advisor Service Fee model is the number 1 question I would suggest asking when selecting an advisor. There are a couple of different ways that your advisor benefits and it’s very important to know the difference.
Direct Payment: This is a fee paid directly by you to the person who helps you manage your money. It typically is paid either directly from your account in a separate line item or via check and is based on the assets in your account.
For example, our typical fee is 1%. On a monthly basis, we take the ending value of the account and multiply it by .083%. The pro of this is that we benefit and lose alongside of you. Our goals are aligned. As your account’s market value increases, the absolute dollar value of our fee increases. As it goes down, so does the amount we collect. If you are invested in mutual funds, another pro is that we are not incentivized by the fund company or trading. We have no subconscious biases that push us toward swapping out funds. We only profit based on your account value.
The con of this method is that we continually charge you this fee. If you are with an advisor that sets your line-up and never looks at it again, doesn’t check-in with you, and just lets your money ride, you could potentially pay them for doing nothing.
Loaded Investments: Some advisors don’t charge a fee directly. Instead, the investments that they purchase for you generate a commission, part of which, they receive. You can see these in “front-load” or “back-load” funds. A “front-load” comes out at the time of investment and a “back-load” comes out when the investment is sold.
For example, when the advisor makes a $100,000 purchase into a 5% “front-loaded” fund, the buy costs the investor $100,000 but they only receive $95,000 worth of the fund. The other $5,000 pays those involved with the sale of that fund, including your advisor. Your statement won’t show the fee broken out, but it is factored into price you paid for the transaction.
The pro of this is that you only pay your investment advisor when they make a trade. The con is that you lose a large percentage immediately and it can’t grow. This is less of a problem with back-loaded funds; however, in either case, your advisor is incentivized to trade because buying a new fund generates revenue.
As you can see on the chart this week, all else being equal, the “load” method works in your favor if your advisor buys and holds the same fund for at least the number of years equal to the percentage of the load; otherwise, you should prefer the direct payment method. The dashed and dotted lines show what happens to wealth when a loaded fund is traded more frequently.
I want to note that there is another fee that varies between fund share classes: the 12b-1 fee. It throws an additional wrench in things. This fee (or lack thereof) could actually be presented as an advantage for both a directly paid or a sales commission paid advisor, but I’ll get into that next week.
If you are using an advisor to help navigate the rivers of investments, you have chosen to pay a fee of some sort in the hopes that you will have a smoother experience than if you did it alone.
When I hired my raft guide, I knew I was paying a company for the trip and that my raft guide was getting a slice of that fee. I knew he was hoping for a tip directly as well. I had a clear understanding of the flow of money and the incentives it created. Investing your money should not be any different. Happy rafting!