This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Thursday, March 27, 2008

What are you really paying for advice?

Posted By Paul

I don't want to come out as the guy who says "you're being robbed if you have an adviser" because it's really not true. I know people who have been with their advisers longer than they have been with their spouse, and trust them totally, and that's great.

HOWEVER, I wanted to lay out a little scenario so that people know HOW you're paying for advice and how much it might cost you.

Let's say that you have $10000 and you want to put it into a mutual fund. We'll go through it step by step, and cover the cases where you have an adviser and one where you don't.

Step 1: Opening the account
With an adviser: You tell your adviser you want to invest $10000 in a mutual fund, and they open an account for you, most no cost advisers work for a specific brokerage company, so you'll get an account with that company (for this example, I'm going to use Black Rock as the family of funds).

Without an adviser: You create an account somewhere by yourself, the advantage is that you can pick from ANY broker you want. So let's say you decide you like Vanguard funds so you open an account with them.

Time advantage:
With the adviser you probably save the time of picking a brokerage. You probably fill out more or less the same forms either way.

Money advantage:
None. Either way it's easy to find a place that will let you open an account for no cost.

Step 2: Picking the fund

With an adviser: Your adviser will probably ask you a few questions and say something like you want to invest in a "Mid Cap Value" fund (this is just an example) and present you with a fund from their brokerage company. In this case for this adviser it would be BlackRock Mid Cap Value fund (BMCAX).

Without an adviser: You would have to decide what type of fund you want, this could take some time but would probably come down to how much you are willing to risk loss of your investment versus potential returns.

There are tools that help you with this, such as this asset calculator.

For the sake of this illustration I'm going to assume that you ALSO decide that you want a "Mid Cap Value" fund. I did a quick check in Vanguard for their Mid Cap Value Fund (VMVIX).

Time advantage:
You saved the time of picking and researching the fund, which could be a lot depending on how much time you like to research that sort of thing.

Money advantage:
At this point, none.

Step 3: Investing the money.

With an adviser: You give your check to your adviser for $10000 and they deposit it in your account and buy the shares. HOWEVER, advisers generally sell loaded funds that have loads or fees involved. In this example BMCAX has a 5.25% front-load. So of your $10000, $525 comes off the top and the remaining $9475 gets invested in the fund (there might even be an additional transaction fee depending on your adviser).

Without an adviser: You give your check to Vanguard and they deposit it. VMVIX has no loads so your whole $10000 goes into the fund (I'm pretty sure Vanguard doesn't charge a transaction fee).

Time advantage:
None really. Putting the trade through is easy either way.

Money advantage:
The adviser route has cost you $525.

Step 4: Fees associated with the fund.

With an adviser: There will be fees associated with the fund.

Without an adviser: Again, fees associated with the fund.

Time advantage:

Money advantage:
While your money sits there, some percentage of your investment goes to administrative fees. For our Vanguard fund it's .26%, for Black Rock it's 1.25%. As far as the fees associated with the fund the Black Rock costs almost five times as much.

Step 5: Fund performance.

With an adviser: You sit back and hope your fund goes up.

Without an adviser: Same thing, fingers crossed.

Time advantage:
None, you sit back and wait.

Money advantage:
Well that depends on how well your fund does. Here are the two funds for the last six months. Notice how similar they are? Maybe in some cases the fund your adviser suggests will dramatically outperform a similar fund, but I'd say most of the time it won't

Step 6: You sell it.

With an adviser: You ask your adviser to sell your fund.

Without an adviser: You contact the broker directly and put the trade through.

Time advantage:
Essentially none, contact your adviser vs. contacting the broker directly.

Money advantage:
In this case none, but be aware that many adviser based funds also have a deferred or "back end" load, which means that a percentage of your investment is taken out as a fee when you sell.

Total difference:

In my example for our $10000 investment, by using an adviser we paid $525 up front, about 5 times the annual fee percentage, and the same fee (zero) at the end. Fund performance was essentially the same.

For that money what we got was the suggestion of the fund category.

If the fund recommendation is worth the money to you, then by all means pay it. In general I would recommend that everyone go through this exercise with their funds and find out:

1) Are paying a lot of front and back end loads for their funds?
2) Are the fee expenses for their funds unusually high?
3) Are the funds performing better than similar funds that don't have the fees?

If you read my previous post:
A Few Quick Tips On Mutual Funds

You'll see how easy it is to use web resources to check your funds.

If you know the answers to these three questions then you can really decide if the money you are paying to your adviser is worth it.


Rachel @ Master Your Card said...

I have mixed views about advisors. I am sure many are very reputable but in my experience they are slow and do things in their best interest rather than yours. Of course you need to know somethig about investments to handle your own affairs.

Paul said...

I think that what troubles me is when people talk like an adviser is a necessity. I view paying for financial advice the same as paying for someone to mow your lawn or change the oil on your car. It's probably something you could do yourself, it is a service you're paying for, and you should be sure that you're service provider is doing a good job.