Why Advisors Need to Pay Greater Attention to Fees

Advisors are beginning to pay more attention to fees, and acknowledging that they are an important part of the discussion. Many advisors, rightly so, do not want to discount their fees much because of the value they bring. It’s not just financial planning or investment advice, it’s also the behavioral coaching part of it. And even Vanguard has found that behavioral coaching is worth 1.5% per year.

Disclosed vs. Hidden Fees

The great majority of advisors I know offer their services for a fee, primarily based on assets under management. Fees typically range from 0.9% to 1.1%. Of course each advisor can charge more or less than that, but that seems to be par for the course. And the industry has accepted 1.0% as a reasonable charge.

The AUM fee is an example of a disclosed fee. It is on Form ADV and often disclosed on an advisor’s website or marketing materials. I do not believe an advisor’s fee needs to come down; I am more about helping advisors ensure that they actually earn that fee (many do not). Much of an advisor’s fee today is hidden – in the form of expense ratios and trading costs of actively managed mutual funds. That is the fee I am most concerned about.

Doing What is Right For the Client

I believe there are certain managers and management styles that are unique, and may offer value to a portfolio. I actually own a few actively managed funds and recommend them as well to clients. But there are way too many “closet indexers” out there; too many funds that aren’t different enough to justify their fees. One negative with instant dissemination of information, and having lots of skillful managers out there, is that it levels the playing field. Luck starts playing a greater role in outcomes.

A great Morningstar article by Jeffrey Ptak concludes that, “fee differences appear to account for an even greater share of performance differences than before.” This article is not saying we should be putting all our money into index funds. It simply makes that case that the greatest predictor of outperformance is cost of the investment.

So why are advisors still using high cost funds that don’t have a unique approach? (BTW, just saying an approach is unique doesn’t mean it is). Well, those high costs allow wholesalers to pay for client appreciation events, golfballs and lunches for the advisor. That’s not necessarily a negative. But if advisors are using their clients to indirectly reimburse their business expenses, then they aren’t doing what is right for the client.

Changing the Industry

Advisors have incredible power to change the industry for good. I think every advisor would prefer that a mutual fund reduced its cost. Advisors can encourage change by seeking out lower cost funds for their clients. This would be right for clients, and it would encourage mutual fund companies to lower their expense ratios. If millions of dollars are heading out the door, the fund companies can only do one of two things – shut down or lower their cost.

And if there is one thing we all understand, it is that money talks.

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