June 22, 2023

JF3213: Understanding Financial Advisors and Their Fee Structures | Passive Investor Tips ft. Travis Watts



Passive Investor Tips is a weekly series hosted by full-time passive investor and Best Ever Show host, Travis Watts. In each bite-sized episode, Travis breaks down passive investor topics, simplifying the philosophy and mindset while providing tactical, valuable information on how to be a passive investor.

In this episode, Travis discusses the ins and outs of working with a financial advisor and understanding their various fee structures. He shares the dangers of using a percentage-based fee and advises working with a fiduciary financial advisor who has your best interests in mind.

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Travis Watts: Welcome back, Best Ever listeners, to another episode of Passive Investor Tips. I'm your host, Travis Watts. I have a very important episode to share with you here today. What we're talking about are financial advisors and their fees. Disclaimers as always, I'm not a financial advisor myself, not a CPA, not an attorney, not telling you or anyone what to do with your money, so please always seek licensed financial advice.

So with that top of mind, let's talk about that disclaimer that I throw out on every episode here on this series. Let's talk about seeking licensed financial advice. So first of all, financial advisors are not created equal. And equally important, their fee structures are not created equal. So let's examine a few ways that financial advisors can earn an income. This is not an all-inclusive list, but these are the common ways that financial advisors get paid. They can either charge a percentage of assets under management - very common - they could charge by the hour, they could charge a fixed or a flat rate, or a retainer fee, or they could make commissions based on what investments they put you in, or whether they're making a trade or not, or they could have performance-based fees, and these could come in any combination of what you see here.

So how much do financial advisors charge? Well, that's a good question, and I want to start by talking about percentage-based fees. Let me ask you a question - does a 1% fee sound pretty reasonable to pay someone? After all, most of us are leaving tips at a restaurant at 15% or 20%. You may be paying 20% plus in federal taxes. I know the sales tax here in Florida is 6%. So 1% seems pretty reasonable, right? So I want to share a story with you to help paint the picture of how reasonable a 1% or maybe a 2% fee is. And this is a personal story. This is about my grandmother who passed away several years ago. She was an amazing woman. She had a great heart. I had a special connection with my grandma. And like a lot of people who grew up in the Great Depression era, she had a bit of a saver's mentality, a low-risk profile, and was part of the bigger societal problem that we have, which is little to no financial education when it comes to investing.

And up to this point, us as a family knew very little about her finances. It was never something she discussed or brought to us. And after she passed away, the story unfolded a bit further and we found something that was very disheartening. We discovered she did have a financial advisor, who was charging her a 1% fee. She also had a 1% fee on the investments in her portfolio, and because of her age, and because she was retired, and because she had a low risk tolerance, she was primarily invested in fixed income instruments that had a very low yield year over year during this timeframe. And this was all before the recent uptick in the federal funds rate that we have today in 2023.

So let's examine why this was such a problem... The 10-year Treasury yield over this timeframe that I'm referring to, this decade that we were looking at in her brokerage account - the yield had been hovering somewhere around 3%, from 2009 to 2018, at some points getting as low as one and a half percent. Now, I want to quickly explain something that is obvious, and something else that's not so obvious. The first thing is that my grandma was being charged 2% a year in fees, while her investments were earning an average of 2% to 3% per year. So when you subtract those fees, the simple math is there were years where she actually lost money, even though the portfolio technically grew. And in a good year, let's say she made 3% yield - well, she had to deduct 2% off of that, so she made 1% in her account, which is why the account was pretty stagnant over the last decade.

So what's not so obvious is how a 1% or 2% fee can substantially impact the growth of your portfolio over the long run, and that's what I want to show you in this episode.

Break: [00:06:34.22]

Travis Watts: So what I'm using here is a free calculator found on nerdwallet.com, but there are literally hundreds of these calculators online that you can use for free if you want to plug in your own numbers and play around with this a bit. Alright, so I'm gonna plug in some numbers here, and let's say that you're 50 years old today, and you've got an investment portfolio of $1 million. We'll assume that you're going to live to be 90 years old, so that's 40 more years to go, and we'll say that you're not planning to add any additional money to this portfolio; you're just seeking the growth over time, and hoping that that compounds for you. I'm going to plug in an annualized rate of return of 8%, and obviously, that's just for example purposes. And I'm going to plug in a 1% fee from a financial advisor. So check this out. This is fascinating. So the portfolio actually grew to a gross amount of over $21 million in this 40-year timeframe, again, starting with 1 million in the portfolio. But what you're left with net of the fees is less than $15 million. So in other words, you just paid a financial advisor or a firm $6.7 million dollars. You still think a 1% fee sounds reasonable?

So let's plug in my grandma's financial advisor fees, and we'll change this quickly to a 2% fee. Same outcome on the gross numbers, the portfolio grew to $21,700,000 and some change, but now you're only left with $10,285,000. So in other words, you just paid a financial advisor or firm $11.4 million in a little 2% fee just added up to taking away over 50% of your growth potential.

So please hear me out on this real quick... Number one, you do not need to pay a percentage-based fee when you hire a financial advisor. There's literally thousands of financial advisors out there that will work on a much smaller container fee, a flat rate fee, or even an hourly fee. Just think about it this way - if you just have four phone calls per year with a finance advisor for the next 40 years, and each of those phone calls cost you $40,000 out of pocket, that would actually be cheaper than paying the 1% financial advisor fee. And again, the good news is there's so many financial advisors out there that are willing to be compensated on an hourly basis; let's say it's between $200 an hour and $400 an hour, versus $40,000 an hour. So you can literally save your portfolio millions of dollars over time by considering an option like this, if you're the type of person that is looking to hire a financial advisor.

And on a final note, please understand that not every financial advisor has what's called a fiduciary responsibility. You might think just because someone is managing your money, that it means they're a fiduciary, but not all financial advisors fall into this standard. Only fiduciary financial advisors are required to place your best interest before their own. I know that sounds crazy. Fiduciary financial advisors could work as an RIA, a registered investment advisor, or they could be a certified financial planner, which is a CFP, but you're going to want to check ahead of time before you hire someone and begin working with them.

So whether you're a stock investor, whether you're a private equity investor, whether you're a combination of the two and you're seeking a financial advisor for some help, please keep this fee structure in mind. Something to think about here for the week.

You're listening to Passive Investor Tips. I'm your host, Travis Watts. If you ever have questions or want to take a deeper dive, let's connect. I'm on Bigger Pockets, I'm on LinkedIn, I'm on Facebook, I'm on Instagram, either @PassiveInvestorTips, or @TravisWatts. Always happy to be a resource or mentor to you. Feel free to share these episodes with anyone you think could find value. Have a Best Ever week, and we'll see you in the next episode.

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