Lessons I learned by using a fee based Assets Under Management investment advisor
TL/DR
An investment advisor who charges a fixed percentage on your investments may not have your best interests in mind. You can achieve better returns through simpler, less expensive means.
Why write this
Till recently, a significant portion of my wealth was managed by a fee based AUM (Assets under management) investment advisor. A fee based AUM advisor charges a fixed percentage of your assets as fees. For instance, my advisor charged 0.9% of the assets as fees each year. They charge this no matter what happens to my portfolio value, it does not matter if it grows significantly or shrinks significantly.
If your eyebrows are raised at this point and you conclude I am a fool, you are right. Rest of this post does not apply to you. This post is for people who use a fee based AUM advisor for various reasons. I also introduced over 40 different individuals to this advisor and my back-of-the envelope calculation says that is close to $10m in assets under management. I feel that I owe a responsibility to explain to those 40 people why I am not doing this anymore. This is mostly friends and family I care about, this should have been an email, but I suspect this can help others as well. Not many people are willing to talk loudly about their foolishness and mistakes.
It is not my advisor, it is me :)
Why did I hire an advisor?
I was afraid of money. That is the short answer. I had no formal education in managing money and I was afraid of investing and managing my money. It is entirely my fault that I did not level up my skills and knowledge to do the fundamental thing an adult has to learn — how to manage their own money.
I was mature enough to realize that I behave irrationally when it comes to money management and I react with emotion when it comes to money; early on in life I saw that I sold when the market went down and bought when the market went up. I was sensible enough to realize that that is not sustainable and has to change. However, instead of fixing it the right way (by learning how to manage money), I took the easy way out and handed over the reins of my accounts to an advisor. This advisor came highly recommended by people I trust and look up to, who still use them.
To be fair, the advisor more or less does what he advertises, which is to invest your money and return you some value. This post is to disabuse myself and others who may be in a similar position of what a AUM advisor does and what he does not, so your expectations are set correctly.
Money management is scary, until is not.
What are your advisor’s incentives?
Incentives matter. I thought I was a student of behavioral economics. I read all the Dan Ariely’s books. I read all books by Dubner and Levitt (of Freakonomics fame). I listened to the Freakonomics podcast and marveled at human psychology and how stupid people behave. Little did I know that those books were actually holding a big mirror to show my blind spots when it came to money. The books were telling me to watch out for my advisor’s incentives.
Your advisor’s incentives are to maximize his 0.9% returns.
Since the advisor makes more money if your money grows, they are motivated to increase your funds. However, it is only a fraction of potential gains. They are not motivated to increase your gains, they are only motivated to increase the base money under their management. The advisor will do everything he can to protect the base, even if it comes at your cost.
I also read that some advisors hold a ~5–6% cash position. What I did not realize is it is done so that the advisor can deduct their fees from the cash holding and that is legal. Another example why your advisor’s incentives are different than yours.
Your advisor might do the same mistakes you do
I don’t know how many people use a fee based AUM advisor to beat the market, but I know anecdotally people do use a fee based AUM advisor to protect them from the bottom falling out under them.
When the Covid-19 pandemic started, I was worried sick. I had read enough that I should not react to the market, but when the market tanked and every ounce of my brain screamed at me that I should immediately liquidate my 2040 retirement age fund in 401(k), I knew that I had to not react. I was paralyzed by fear.
I spoke to my advisor for advise and transferred my 401(k) to a Brokeragelink account, after liquidating my 2040 retirement fund and handed it over to the advisor. I was hoping that the advisor will avoid the mistakes a naive investor like me would do.
March, which, with the benefit of hindsight, was the absolute bottom. The advisor held cash for most of the year, buying back after the market had risen.
The responsibility of a fiduciary advisor in a moment like this, for a long term tax-free retirement account would be to stay the course. Forget about the account and revisit it a year later.
My 401(k) for the year that ended Jan 29, 2021 looks like this:
When I looked at the returns my advisor provided from March till December last year:
Returns on the 401(k) from March 2020 to Jan 2021: 33.67%
S&P 500 returns the same period with dividends: 75.62%
The advisor managed brokeragelink returned 33.67% for rest of the year when S&P returned 75.62% (with dividends). This a number that I got from the advisor’s own performance portal.
Your advisor will do the same mistakes you do, since they are human, and will charge you 0.9% for it.
If you are a boglehead or a believer of lazy portfolios or even if you had read Ramit Sethi, you know this is *exactly* what is expected out of active money management. The year 2020 is a magnificent example of why lazy portfolios work.
Another friend of mine gave a huge chunk of money to the same advisor. The advisor did not invest it using dollar cost averaging or value averaging, they invested the whole thing in one bulk. The market dropped immediately right after and it took years to recover. Is this something you expect your advisor to do?
Constantly measure your advisor’s returns
Often, it is impossible to find out what your advisor’s returns are. There are multiple conflicting numbers to measure returns. Your advisor will quote you numbers that will be completely accurate but useless to you. As a client, what you need is to easily find out how to measure your advisor’s returns. Often it is as simple as finding the $ difference between Jan 1 and Dec 31. Maintain a spreadsheet and compute it yourself.
Of course if you contribute multiple times mid-year to the same account, you have obfuscated your numbers for your own sake.
If you want to measure your advisor’s performance, leave an account untouched for a year, do not contribute to it. Look at the gains end of the year and compare it to what it was on Jan 1.
Beating S&P 500
If I had a $ for every time my advisor said he would beat S&P 500, I would have paid 9 cents to them each time.
I agree that you don’t measure an advisor’s performance over a year or two years. These are the returns of my advisor over a period of eight years. This is before the 0.9% advisor fee.
Apparently, it is almost impossible for an active investor to beat the S&P 500, consistently and regularly. I am sure there are investors who can do that.
Ignore the claims of advisors who say they can beat S&P500. Aim for average market returns over the long term.
Compound interest is not fun when it works against you
Compound interest is great when it works in your favor, it hurts when it works against you. Take a look at this managed funds fee advisor calculator: https://moneysmart.gov.au/managed-funds-and-etfs/managed-funds-fee-calculator.
For instance, if you start with $400,000, add $1,000 a month to it, for a period of 15 years, at a 7% return, giving 0.9% to your advisor, this is what happens to your funds.
Nearly 20% of your gains go to your advisor.
You almost pay a fifth of your gains to your advisor over a 15 year period under normal conditions. Compound interest sucks. You are enriching your advisor, not yourself.
For most ordinary investors, lazy portfolios work
There exist a significant population of investors who believe in investing in lazy portfolios. These are portfolios where you decide a set of very low cost mutual funds, invest in them, forget about them, login once a year to your account to rebalance to bring it back to your original decided allocation.
https://www.marketwatch.com/lazyportfolio has a list of such interesting lazy portfolios. The goal is to aim for average returns every year. Year after year after year. Let compound interest work in your favor, save on fees and let it grow.
I have a friend, who is very lazy with money. With invested money, it is a good thing. He had a 401(k) from 2007. He put it in a lazy portfolio of primarily a 2040 age retirement fund and a few other low cost mutual funds. He forgot about it. He heard my sob story and checked his 401(k) account today. This is what he sees.
He tripled his funds over a 14 year period by doing nothing. He setup his accounts one time, left the money there and forgot about it. That is the best way to invest.
Lazy portfolios work for most people. Average returns every year over 15 years will most likely beat active investing.
Setting your expectations right
I had a misconceived notion of what I was paying for. When I paid 0.9%, I thought I was paying for someone to manage my financial life. I wasn’t. I was paying for someone to manage my Fidelity account and return some money. That is what the advisor fee is for. The fee is not for the advisor to invest it in the best possible investment for my life’s needs. Likewise, when I pay the $700 tax filing fee, I am paying the advisor for the mechanics of filing the form and submitting it to IRS. I am not paying the advisor for tax advise on how to save on taxes.
Set your expectations right about your advisor. You are paying for the mechanics of doing a job, not a solution for your personalized needs.
You are not special
When I compare the asset allocation in my tax free accounts and compare them to the asset allocation in my taxable accounts, they looked very similar. If you start learning the basics of investing, you know that those two should be handled very differently. Worse, when I compare my asset allocation to my friends’ accounts, they look exactly the same, even though our life’s circumstances are very different and warrant very different investment approaches.
Your 0.9% fee is not getting you bespoke treatment. Your account is another entry in a bucket of investment portfolios in a cron job.
Money is awkward with friends
I introduced my best friends to this advisor. One of them quit this advisor in a couple of years saying some of the reasons mentioned above. Note that this is a friend I trust my life with. I am afraid of heights and this friend took me to the top of Mt. Whitney. He, along with a couple of other close friends, helped change the way I eat. He changed my lifestyle. Yet, when it comes to money, even your closest friends tend to not poke their opinion into it, they stay away. Money is a dicey subject.
When you see your friend shying away or saying things mildly concerning about your approach or investments, drill down and ask them to explain why they said that. Ask them to hit you with the facts and unfiltered opinion, and listen to them. Remember that your friends care about your well being, your advisor does not.
Trust your allies, hear them out. Seek out contrarian opinion. Embrace it. Get out of your cult-mode.
Watch out for conflicts of interest
As explained in the cleaning up your tainted IRA post, my investment advisor was also my tax filer / CPA. I ran into a conflict situation because of this dual nature. I wish my advisor had given me accurate tax advise on many occasions.
Watch out for your advisor’s conflict of interests.
Where does all this leave me?
I have learned my lesson, albeit many years late. I hope it is not too late. I will turn 47 in two months and I sincerely hope that I can set this ship in the right direction. I am headed down a path of creating lazy portfolios for me, along with reading as many books as I can. I hope to write more as I go through this journey.
