Comparing DFA money management fees

[mlebuf]

Those who believe that it's very hard to beat the market and that costs matter most will find this very interesting. In his latest post at The Retire Early Home Page, John Greaney posts the money management fee schedules charged by a number of DFA approved advisors. As you will see, there is a wide variation in the amount that firms charge for the privilege of passively managing the client's money. Here's the link:
http://www.retireearlyhomepage.com/low_fee_dfa.html

As I read the fee schedules and analysis, two things I learned from Jack Bogle kept kept turning over in my mind:
1. Just as there is the power of compound interest, there is the power of compound costs.
2. In investing, you get what you don't pay for.

Best wishes,
Michael

[larryswedroe]

Michael
With all due respect, fees are only one side of the table. Do you always buy the cheapest car, eat at the cheapest restaraunt, use the lowest cost accountant, attorney, doctor?

Fees matter, but what matters more is the value added of the services provided relative to the fees.

As one example here, there are a few firms that include the management of fixed income portfolios in their fee, saving the investor the mutual fund fees for that portion of their portfolio. And you get all the benefits of separate account management, like tailoring the holdings to your specific tax rate and state. Where does that show up in the table? Nowhere of course.

Now if all one is paying for is access to DFA then pay the lowest fee because the services are equal.

The skill sets of advisors, as with any profession, vary greatly, and sometimes you get what you pay for, and sometimes you PAY FOR what you get.

As simple example I see many portfolios where there are professional advisors that have the wrong locations, despite the published literature on the subject. There are many advisors that only check for tax management at end of year, when that is, or should be, a round the clock job as opportunities for harvesting losses can disappear. Those are just two of the laundry list of issues one might create.

Each person should evaluate the fees relative to the skills and services offered. And while I agree that good advice doesn't have to be expensive, bad advice almost always costs you dearly no matter how little you pay for it.

[Hedgy]

Well said, Larry.

[INDUBITABLY]

Wow, what a sweet gig! Forget law school, I should be a DFA advisor -- more money, fewer hours, what's not to like?

[grumel]

And the most expensive company has most assets and clients )-:.

[knhifin]

Looking at the lofty fees the DFA advisors currently charge, even for simple, buy-n-hold tax-exempted IRA, one can see how well this DFA product has been orchestrated for the feeding frenzy.

Make me wonder if there's really any walk-to-my-own-drum, reasonable-fee, access-only DFA advisors out there?

[Taylor Larimore]

Hi Michael:
John Greaney, deserves credit for his comparison and analysis of well-known advisors. His conclusion:

The wide range of fees charged by DFA-approved advisors offers potential clients considerable opportunity for savings. Especially for investors with larger accounts, the assets under management (AUM) fee model appears to result in an annual charge that's wildly inflated given the small number of man-hours required to manage a portfolio of 10 to 15 index funds.

If a "high-fee" DFA-approved advisor can't give you a detailed description for what additional services he'll be providing for the tens of thousands of dollars in additional annual fees, it may make sense to hire one of his low-cost, fixed-fee competitors.

Thank you and best wishes.
Taylor

[larryswedroe]

Taylor
I certainly agree with the conclusion (if an advisor cannot justify the fee no one should pay it), though the analysis is very flawed--good example is in the fixed income area. He ignores for example the ability with separate account management to add value in tailoring the assets to specific tax bracket (for example we often find that based on the shape of the yield curve we buy taxables on one part of the curve and munis in another). And we make sure the muni portfolio is tailored to state specific needs (but buy out of state bonds if yields more attractive once we account for taxes)--Mutual funds cannot do this.

and there are many other examples one can add that I did not.

[Rager1]

Hi Michael,

It's nice to "see you" again. Hope to see you and Elke in San Diego at the Bogleheads Reunion in September.

Thank you for posting this piece. It is truly an eye opener. Those costs really do add up over the long term.

Ed

[Drain]

Looking at the lofty fees the DFA advisors currently charge, even for simple, buy-n-hold tax-exempted IRA, one can see how well this DFA product has been orchestrated for the feeding frenzy.

Every advisor in the table has DFA access, so DFA is not a factor in the fee comparison. Or are you making some other point?

[philip]

Hi Michael,
Thanks for providing link. It is indeed an eye opener. For a 1MM account size, adviser fee ranges from
1K to 14K. IMO It is very hard to believe that whatever tax or fixed income strategy those high fee adviser
implement, that is going to beat such a large difference. With the availability of ETFs, average Joe
can creates a well diversified tax efficient portfolio. Besides, tax laws are not static, I wonder how well
advisor's tax strategies will succeed if congress make significant changes in the tax laws in the future.
Bogle taught us cost matters. Just wonder what he thinks about those fees.

[BeachPerson]

Once in awhile I catch Ric Edelman on the radio and he says that with his firm that he does a complete 360 analysis to look at insurance and to see if a person should pay down debt instead of invest.

Rick Ferri jokes that with his firm, he does not give tickets to the ball game.

[larryswedroe]

I don't want to get into a long and really unproductive discussion
But the differences in fees, especially at the higher levels can easily be swamped by how aggressive one is in harvesting losses, by managing fixed income assets as separate accounts and tailoring to specific situations, by getting asset locations correct, by choice of the correct funds and allocations, and all kinds of issues related to insurance, estate and tax planning, management of stock options and concentrated portfolios, etc.

[Rager1]

philip wrote:

Bogle taught us cost matters. Just wonder what he thinks about those fees.

Here is what Jack Bogle said in a 2005 speech at an American Association of Individual Investors meeting:

"First, pare costs to the bone. Realize that in investing you get what you don't pay for. Whatever future returns the stock and bond markets are generous enough to deliver, few investors will succeed in capturing 100% of those returns, simply because of the high costs of investing—all those commissions, management fees, investment expenses, yes, even taxes."

Source: http://www.vanguard.com/bogle_site/sp20050524.htm

Ed

[TXoilman]

Michael
With all due respect, fees are only one side of the table. Do you always buy the cheapest car, eat at the cheapest restaraunt, use the lowest cost accountant, attorney, doctor?

Fees matter, but what matters more is the value added of the services provided relative to the fees.

As one example here, there are a few firms that include the management of fixed income portfolios in their fee, saving the investor the mutual fund fees for that portion of their portfolio. And you get all the benefits of separate account management, like tailoring the holdings to your specific tax rate and state. Where does that show up in the table? Nowhere of course.

It looks like the author addressed that specifically in the article.

A low-fee DFA advisor might not do as good job at tax loss harvesting -- One high-fee advisor on the list, Buckingham Asset Management advertises their willingness to manage a portfolio of individual bonds at no additional cost. This allows them to take advantage of tax loss harvesting at the individual bond level. Is this enough of an advantage to offset Buckingham's much higher fees? Let's investigate.

For example, for a client with a $5 million portfolio, there is a $22,000 per year difference between Buckingham's annual fee of $25,000 and the $3,000 charged by a fixed-fee advisor. If we assume the client has a 50% allocation to fixed income ($2,500,000), he would be paying between $2,750 and $4,750 in mutual fund management fees, depending on the fund. (Vanguard's Short-Term Bond ETF (BSV) has an expense ratio of 0.11%, DFA's One-Year Fixed Income Fund DFIHX has an expense ratio of 0.18%, while the DFA Two-Year Global Fixed Income Index DFGFX has an expense ratio of 0.19%.) Of course, a portfolio of individual bonds would incur brokerage commissons and the additional costs of the bid/asked spread on each transaction. These costs probably offset the savings in bond fund management expenses. For a taxpayer in the top Federal bracket, short term gains are taxed at 35% and long-term gains are taxed at 15%. That means Buckingham would have to generate somewhere between $63,000 and $147,000 in tax losses to net the client a $22,000 annual savings on his tax return (depending on whether it's a long-term or short-term loss.) Could Buckingham deliver the $22,000 in annual tax savings required to absorb its higher fees with any regularity? I'm skeptical.

What's been the experience at your firm? Can you regularly supply your clients with sufficient tax losses each year on a $2.5 MM bond portfolio to "earn back" the additional $22,000 per year in fees? Also, how do you account for the additional costs in trading individual bonds? The bid/asked spread on replacing one $100,000 bond with another to harvest a tax loss is at least 1% to 2% of the bond value.

TXoilman

[larryswedroe]

TXoilman
All the author did was show his ignorance of the situation. The value added is not limited to the ability to harvest losses at the individual security level but in other ways as well
For example, often the yield curves are different for taxables and munis. So that sometimes we buy taxables for one part of the curve and munis for another, increasing yields.
Another example is being able to tailor the munis to a client's specific state---and also to buy bonds that have the highest return whether or not it is specific to the home state. Often there are no state funds, or state funds that have the right average maturity for clients.

And how about making sure the credits are appropriate---wonder how many people would like to have owned safer bonds? And how much is that worth?

And there are of course many other ways a good advisor can add value--as I stated, like just getting location right. And for example showing that it is more efficient to tilt more with lower equity allocation in taxable than to hold equities in tax advantaged account.
I fully agree that costs are important. But the most important thing is value added. And I fully agree that if you cannot demonstrate value added then the investor should go elsewhere.

[TXoilman]

TXoilman
All the author did was show his ignorance of the situation. The value added is not limited to the ability to harvest losses at the individual security level but in other ways as well
For example, often the yield curves are different for taxables and munis. So that sometimes we buy taxables for one part of the curve and munis for another, increasing yields.
Another example is being able to tailor the munis to a client's specific state---and also to buy bonds that have the highest return whether or not it is specific to the home state. Often there are no state funds, or state funds that have the right average maturity for clients.

And how about making sure the credits are appropriate---wonder how many people would like to have owned safer bonds? And how much is that worth?

And there are of course many other ways a good advisor can add value--as I stated, like just getting location right. And for example showing that it is more efficient to tilt more with lower equity allocation in taxable than to hold equities in tax advantaged account.
I fully agree that costs are important. But the most important thing is value added. And I fully agree that if you cannot demonstrate value added then the investor should go elsewhere.

I'm sorry. I understand that advisor fees are a sensitive subject.

How does one quanitify each of the "value-added" points you mention? Perhaps we could start with how much of the $22,000 in additional fees is recaptured in tax loss harvesting and move on to the other points you've mentioned.

Also, I'd be really interested to learn how buying and selling indivdual bonds to capture tax losses incurs less fees than holding a mutual fund with a 0.10% to 0.20% expense ratio. Does your firm have some way to trade individual bonds without incuring the bid/asked spread that retail investors must pay?

TXoilman

[at]

I fully agree with Mr Bogle's view that cost matters. Evanson Asset Management seems to be in the sweet spot of having a low fee and large client base. What do you guys think of this company?

[Levett]

at--

I can tell you that when I spoke with a very well-known money manager/author in behalf of two members of our extended family Evanson was the first firm he recommended. This is a person whose judgment I trust in all respects.

Beyond this piece of information, I have nothing else to say, aside from agreeing that costs really do matter. Bob U.

P.S. I am a DIY investor who uses TIAA-CREF and Vanguard products.

[larryswedroe]

TXOilman
First the value of an advisor can go way beyond the issues we discuss here. And there is no way to put a hard figure on some of the issues.

And even here with fixed income there is no way to put a hard figure as it depends on many things. The shape of the various yield curves, the state a person lives in and their tax rates.

But let me address a few things

First, we basically buy bonds at about the same prices that Vanguard or DFA does. We buy about $2b a year and shop the street (putting in competition say 4 or 5 dealers each time) and take the best bid or offer. Also we aggregate trades to get the price. And of course we save the OER.

But as I said, when we build a ladder we check the individual's tax rate and the various yield curves and sometimes buy taxables on one part of the curve and munis on another. That adds value over a fund that is only using one of the two. Another benefit of course is that you control the maturity and most importantly the credit risks (an issue that was always important but people are only now seeing that because the risks are showing up now). But we also can build state specific muni portfolios were there are no funds and we don't simply just buy the bonds of the state one lives in. We check to see which bonds have the highest AT return, and it quite often can be bonds of other states.

And then of course there is the ability to harvest losses.

But as I said this is only one small part of how a good advisor can add value. Again I don't want to get into long discussion but from my experience most advisors only check for loss harvesting at year end while we do it virtually daily. In some cases we have already made two round trips this year harvesting losses. Now those losses may not be there by year end if you don't harvest them now. Or they might be long term instead of short term (which are more valuable).

I hope the above is helpful.

[baw703916]

A few comments from a DIY who tries to imitate DFA-based portfolios with Vanguard funds and ETFs...

One comment from a data-presentation point of view about the article--the bar graph of account value after 30 years is visually misleading. The axis starts at $10 million, not at zero. So the difference due to advisors' fee structure is much less than it appears at first glance (without reading the scale on the horizontal axis). Someone starting at $1 million will have in every case between $13 million and $17 million. If you really have a portfolio shooting for a 10% return, the dispersion in possible outcomes due to what happens in the market in the next 30 years is liable to be at least this big...

I think all of these outcomes should be just fine. The only thing that someone with $1 million and 30 years needs to do is to avoid a big mistake, like betting everything on the Nasdaq in the late 90s or (maybe, we'll see) on gold right now.

With all the ETFs which have recently come out, it's possible to very closely replicate a DFA-based porfolio--you can have emerging small cap, international small cap, international real estate, US microcap, international value, etc., etc., even though Vanguard still doesn't offer any passive options for these asset classes.

So I don't think access to DFA is a good reason to get a FA...a good reason is to have someone to keep you from making a big mistake, or if you are too busy or don't have the inclination to DIY. Someone who actually has a $1 million portfolio while they still have a 30 year time horizon might be to busy managing a business to effectively manage their portfolio..

Best wishes,
Brad

[HerbertSitz]

First the value of an advisor can go way beyond the issues we discuss here. And there is no way to put a hard figure on some of the issues.

Larry -- I'm sure that's true, but I admit I'm skeptical that high-fee advisers are the only ones who provide the extra value.

Take the bond portion of the portfolio, for example. I'm wondering roughly how much value can be added to a bond portfolio by taking advantage of individual bonds, block pricing, tax loss harvesting, laddering, buying with terms at optimal point of yield curve?

I realize there's some benefit that should be expected of that, but if an adviser's fees are, say, 80 or more basis points it just seems like a practical impossibility that results are going to be enough to justify the extra costs over using a lower-priced (say 25 bips) but skilled adviser who manages things using bond funds. It seems like there's just not that much juice to squeeze from the fruit, given the very efficient bond markets and the relatively low risk and return premium of bonds.

Are there any studies you know of on how much can be eked out of individual bond portfolios versus portfolios built of more coarsely cut bond funds? Any numbers from your own experience?

Also, are there no bond funds that do internal tax loss harvesting? If not, I'm wondering why not. It seems like an obvious thing for them to do.

[larryswedroe]

Herbert

First, I never said that a "high fee" advisor is the only one that can add value. The size of the fee has NOTHING to do with how much value one can add. You can just as easily have a bad advisor (or at least one adding little value) at a high fee as a low fee. For example, Rick Ferri does at least some individual bond portfolio management (I don't know the degree but he can clarify) and he is a "low fee" advisor. Now compare his fee to someone who is even lower and if we assume that they are equal in skills and services and how much attention they pay to the account (like how often they check for loss harvesting) then Rick is going to add more value. That shows a simple example of how looking only at fees can be a mistake.

Second, I don't know how to exactly quantify the benefits of individual account management as it shifts alll the time as it depends on things like the shapes of the yield curves and how volatile rates are (the opportunities to harvest losses are larger the more rates move) and someone's tax rate. I certainly would not say that it could add 80bp a year, because there is no active management going on. But could it add say 30-40 or perhaps more to the fixed income side? Yes. Again it depends on the situation.

But that is just one small example. How often one checks for loss harvesting can be a significant difference for example. Or just getting the location part right can be a big difference (like, IMO, the mistake of owning junk bonds when have choice of location). Or more importantly, getting the asset allocation right in first place. For example IMO it is important (though not a perfect tool) to use MC simulations to help in the decision process. I don't know how one can decide really on an AA without going through that process because you cannot evaluate how different AAs can impact the odds of success (depending on how you define success, and there are various definitions, not just not running out of money, might be to have at least $x at death to leave to kids). Yet doing that type analysis takes lots of time and effort. Just gathering the data and then making sure it is input correctly takes time and care. I doubt a low fee advisor would/could take the time and effort to do this even once, let alone whenever someone's ability, willingness or need to take risk changes. In fact we have a team of people dedicated to just this take and portfolio analysis (analyzing the current holdings of prospective clients). So IMO what you will hear from a low fee advisor is reasons why they don't use that tool.

Here is a simple example. After the big run up in the 90s a good advisor would have sat down with clients and pointed out that the returns have been well above expected. You now have the opportunity to lower your equity allocation and still have the same odds of success you had when we began. Now I am sure some advisors had that conversation, and those that took that advice I am sure are grateful for that conversation. And I know other advisors who never had that conversation, in fact one well known advisor even argued that it should not be held, that it would be market timing. I could not think of anything that would be foolish. But you decide who is right. By running a new MC simulation it is easy to show how changing your allocation alters the odds of success. It takes the emotions out of the picture.

Here is another good example. Long term health care is an important issue. The lack of it can ultimately destroy even a well thought out investment plan. How many advisors discuss that and how many show the impact? Of course the size of the fee an advisor charges doesn't determine this. But IMO it does differentiate one advisor from others. To help with this type decision you could run two MC simulations. One with the costs of LTHC in the assumptions and one without. Then you can show what happens if the risks show up--put in additional expenses. And then see what happens. Doing that kind of analysis is helpful in making the decision. This is what we do. You determine if that adds value or not.

I could go on obviously listing many more type situations including even some related to personal property insurance, let alone disability and life insurance, and issues related to estate and tax planning. Just as one example, I don't know how you can manage the tax situation without coordinating the efforts with the CPA. For example we have to know what the marginal tax rates will be to determine whether to use taxable or municipal bonds. And often we need to generate a certain amount of taxable income and then can use munis after that. And often those figures change from year to year. In many clients meetings we often have their CPA and or attorney involved. Again, a low fee advisor can do that as well. The question is do they?

All I am saying is that just as it is a mistake to look at the fees of a fund as the only criteria (because a fund can add value in ways another does not, like DFA has done compared to similar index funds), it is a mistake to only look at the fees of an advisor (unless all one wants is access). Then one can determine, not scientifically, whether they believe the fees are worth the difference.

Let me give one final example. I recently worked with a family to help them develop a family wealth mission statement. Helping them put down on paper what they wanted to convey to their children about the meaning of money to them, how they valued community service, how they valued charitable contributions. The children are then brought into the discussion and issues like their roles in determining which charity will get how much each year are discussed. You decide how much value you put on helping a family ensure that their values are passed on and the family's wealth is preserved or used appropriately. And part of our role is educating the children on prudent investment principles. You may not be aware but something like 2/3 of all large estates are burnt through within the next two generations. What price do you put on helping prevent that?

There are many ways an advisor can add value and each person should decide for themselves what the value of services offered are

I hope you find the above helpful.

[leonard]

Doe DFA Advisors generally help clients manage their DFA plus work 401k's as 1 portfolio? Or, is it a high fee/high service versus low fee/low service advisors?

Just curious.

[larryswedroe]

Leonard
Every firm has a different business model. As you can probably tell from my posts there are some that offer very limited services and very limited interaction with clients and some that offer a wide variety of services and a high level of personal interaction across issues that go way beyond investing.

I am not saying that one model is better than the other. Each individual should carefully consider the services offered and their value relative to their own needs and wants. Then make a decision. But choosing based only on costs is as foolish as choosing a doctor or a car or a lawyer or CPA based solely on costs--unless all one is seeking is access to DFA.

Having said that, my assumption is that most advisors would work with both accounts.

[TXoilman]

Herbert

First, I never said that a "high fee" advisor is the only one that can add value. The size of the fee has NOTHING to do with how much value one can add. You can just as easily have a bad advisor (or at least one adding little value) at a high fee as a low fee. For example, Rick Ferri does at least some individual bond portfolio management (I don't know the degree but he can clarify) and he is a "low fee" advisor. Now compare his fee to someone who is even lower and if we assume that they are equal in skills and services and how much attention they pay to the account (like how often they check for loss harvesting) then Rick is going to add more value. That shows a simple example of how looking only at fees can be a mistake.

Second, I don't know how to exactly quantify the benefits of individual account management as it shifts alll the time as it depends on things like the shapes of the yield curves and how volatile rates are (the opportunities to harvest losses are larger the more rates move) and someone's tax rate. I certainly would not say that it could add 80bp a year, because there is no active management going on. But could it add say 30-40 or perhaps more to the fixed income side? Yes. Again it depends on the situation.

That's very useful information.

If you were comparing a low-fee advisor with a high-fee advisor that offered more client contact, estate plannning services, etc.,, and the enhanced fixed income strategy you describe above, what would be a fair fee to pay for the fixed income component alone? (You could then assign a value to each of the other services offered to see if the whole package makes sense at the fee level being proposed.)

If the average client realized a 35 basis point improvement in fixed income returns (versus just using a fixed income mutual fund with simple year-end tax balancing), maybe a few guys got a 50 basis point improvement and few got only 10. Then you'd have to factor in the fact that the advisor gets paid whether or not the client actually sees any improvement in his fixed income returns. Would 10 or 15 basis points in additional fees (on the value of the fixed income portion of the portfolio) be too much to pay given that the client is shouldering all the risk that there'll be no improvement?

TXoilman

[larryswedroe]

TXoilman
There are many firms that offer purely fixed income separate accounts. Standard fees are significantly higher than we are talking about here.
And that is for purely fixed income management alone.

And like I said each person should evaluate the value of the services based on their own situation. Some people will place a high value on some services and others place a low value on those very same services

Thus there is not a right answer.

[Rick Ferri]

larry wrote:

Every firm has a different business model. As you can probably tell from my posts there are some that offer very limited services and very limited interaction with clients and some that offer a wide variety of services and a high level of personal interaction across issues that go way beyond investing.

That is true. Our firm is a portfolio management company and we charge a low asset based fee for that service (AUM). Any other service a client needs is generally done by an independent hourly fee person (CPA, attorney, financial planner etc). That is the lowest cost model for our clients.

Some advisors bundle multiple services together under an asset based fee. Even services that have nothing to do with portfolio management are charged a prorated fee based on how much money is in a portfolio. That model never made any sense to me. I understand AUM as a viable method for charging investment management services, but do not understand using AUM as a mean to bill for insurance advice, tax preparation, estate planning, etc. Those should be hourly fee services.

Rick Ferri

PS. When comparing fees, investors should look at total cost, including the expense ratios and commission costs of the investment portfolio. Many advisors recommend higher fee funds that increase the overall cost of doing business.

[philip]

Is there a financial advisory firm that offer dating service so that the adviser can
help to find a financially compatible partner for their clients ?

[indexnerd]

The market has priced advisor services on a AUM basis and at about 1%. This is the preference of most investors and there is wisdom in this crowd just like all others.

Some of you may think this is foolish and you'll tilt away from the market toward low-cost access or no advice at all. That might work for you. But it also introduces risks you might want to consider. The success of a long-term asset class strategy is influenced to the greatest degree by investor behavior. Tax-management, expense ratios, asset location, and even fund selection (Vanguard vs. DFA) has much less relative impact. Morningstar and DALBAR have both demonstrated this with different methodologies.

An inexperienced advisor; an advisor overwhelmed by thousands of accounts; a firm that has you "serviced" by a "junior" advisor; an advisor who has little financial incentive to counsel clients during both really good and really bad times (after all, it's all about volume of client relationships, not quality); etc. can all be far more costly at a fixed fee than an experienced, committed, well-compensated, disciplined advisor who has much more time to control (in various ways) his or her client behavior. Most investors know this and seek good advice as a result.

I know many people who have tried to adhere to an asset class investing strategy only to succumb to market timing, sector and industry rotation, shifting US/foreign allocation, adding "new" asset classes near their peaks, and so on. These were investors who read both Bernsteins, Ellis, Bogle, etc. Their cost was far higher than 1% per year, as it turns out.

The bottom line is that most of you are trying to quantify something that is really impossible to quantify. You're working around the margins. Nothing wrong with that if you possess the right behavioral traits.

[Rick Ferri]

Is there a financial advisory firm that offer dating service so that the adviser can help to find a financially compatible partner for their clients ?

They are called 'Investment Manager Consultants'. They even have an certification called a "Certified Investment Management Analyst (CIMA)" see http://www.imca.org/.

The organization has a lot of brokers and insurance salespeople as members because the CIMA designation is fairly easy to achieve. Although not nearly as rigorous as Charter Financial Analyst (CFA) or even the Certified Financial Planner (CFP), the course does provide the basics of investment management techniques. In fact, for many members, CIMA is the best unbiased academic training they have ever received because the brokerage firms they work for certainly do not provide it.

Rick Ferri

[ChefJeff]

philip wrote:
Is there a financial advisory firm that offer dating service so that the adviser can help to find a financially compatible partner for their clients ?


They are called 'Investment Manager Consultants'. They even have an certification called a "Certified Investment Management Analyst (CIMA)" see http://www.imca.org/.

Here in Indianapolis, we call them escort services.

[HerbertSitz]

The market has priced advisor services on a AUM basis and at about 1%. This is the preference of most investors and there is wisdom in this crowd just like all others.

This doesn't fit very closely with what I've observed.

1% is a standard aum fee because it's what asset managers get away with charging, not because clients "prefer" it.

Yes, there are plenty of good fee-only asset managers out there that charge 1% and deal exclusively in good low cost index funds and etf's.

But the vast majority of asset managers out there are still fee-based (i.e., they charge both aum fees and get commissions), try to serve two masters by trying to switch between role as broker rep and client fiduciary, sell funds with loads and/or high fees, have wrap accounts, etc., etc., and/or prefer that their clients not know all the different ways money is sucked out of the account. I understand that some of these advisers are genuinely trying to do a good job and believe they're providing a good service to their client. But would the average client want this sort of fee-based service if they really understood what was going on and were fully aware of and understood the advantages of fee-only alternatives?

If you say "clients prefer 1% aum fees" because that's the standard you'd have to also say that clients prefer fee-based advisors because they're still the standard across the industry. I don't think clients do prefer them, at least not fully-informed clients who understand much about investing.

. . . Most investors know this and seek good advice as a result.

I don't think most investors are very good at finding good advice. Far from it. I think most are confused not only about investing, but about how the adviser industry works and how and what fees or commissions are extracted from their accounts. The mere fact that most still choose fee-based advisors who push high fee funds should be proof of that. I'm not sure whether it was Bill Bernstein or Burton Malkiel who said, "Your broker is not your friend." Brokers and advisors are often very good at appearing to be trustworthy (and skillful), cultivating a relationship in which the client believes the broker or adviser really is their friend. (A good adviser may really be a friend, but bad advisers can appear to be, too.) Clients often trust that their advisers have been doing a great job when in fact they haven't. This is especially common in strong markets, when everyone's making money and the clients are happy to see balances growing fast (and don't even notice large fees being extracted).

It just boggles my mind to hear anyone say that the standard 1% aum fee is justified because clients know what they're doing. Not in my world. I'm not saying a 1% fee can't be justified. But the fact that a mass of mostly uninformed and confused clients pay it isn't a part of the justification.

[White Coat Investor]

a firm that has you "serviced" by a "junior" advisor; an advisor who has little financial incentive to counsel clients during both really good and really bad times (after all, it's all about volume of client relationships, not quality); .

Part of the problem is that most advisors "service" clients like Bonnie and Clyde serviced banks. No one would argue that a good advisor is not worth his weight in gold to 90% of investors.

But I think most/many on this forum are in that last 10% where paying extra to an advisor decreases returns when the cost of the advisor is factored in.

[larryswedroe]

The following is my suggestions as I check list when looking for a financial advisor. Someone might come up with another list, depending on what they are looking for in an advisor

When interviewing a potential financial advisor, require them to make the following eleven commitments to you. Doing so will give you the greatest chance of avoiding conflicts of interest and the greatest chance of achieving your financial goals.
1.The firm should be able to demonstrate that its guiding principle is to provide investment advisor services that are in the client’s best interests.

2.The firm follows a fiduciary standard of care—a fiduciary standard is often considered the highest legal duty that one party can have to another. This differs from the suitability standard present in many brokerage firms. That standard only requires that a product or service be suitable—it does not have to be in the investor’s best interest.

3.The firm serves as a fee-only advisor—avoiding the conflicts that commission-based compensation can create. With commission-based compensation, it can be difficult to know if the investment or product recommended by the advisor is the one that is best for you, or the one that generates greater compensation for the advisor.

4.All potential conflicts are fully disclosed.

5.Advice is based on the latest academic research, not on opinions.

6.The firm is client centric—advisors focus on delivering sound advice and targeted solutions. The only requirement they have in offering particular solutions is whether the client’s best interests will be served.

7.Advisors deliver a high level of personal attention and develop strong personal relationships—and clients benefit from a team of professionals to help them make sound financial decisions.

8.Advisors invest their personal assets (including the firm’s profit-sharing plan) based on the same set of investment principles and in the same or comparable securities that they recommend to their clients.

9.They develop investment plans that are integrated with estate, tax and risk management (insurance) plans. The overall plans are tailored to each client’s unique personal situation.

10.Their advice is goal-oriented—evaluating each decision not in isolation, but in terms of its impact on the likelihood of success of the overall plan.

11.Comprehensive wealth management services are provided by individuals that have the CFP, PFS, or other comparable designations.

[Rick Ferri]

I agree with Larry, and will also add that there needs to be accountability from the manager for performance.

I do question his statement that advisors should "deliver a high level of personal attention and develop strong personal relationships" with clients. Investment management is a business and investment advisors should act as professionals. It is good to be business friendly, and it is important that the advisor know each clients' financial situation so that they can best advise them, but IMO, an investor should not want to develop a strong "personal" relationship with anyone who is paid to manage their money. That is not in the investor's best interest. This advice comes from about 20 years of personal experience working with individual investors every day and managing their portfolios.

Larry also says that "Comprehensive wealth management services are provided by individuals that have the CFP, PFS, or other comparable designations." While those designations do signify a certain level of educational commitment, and having a designation is usually better than not having one, they do not guarantee professional competence. I know several advisors who do not have a CFP and are more competent than some that do. In fact, many members of this forum are far more competent than some advisors I have come across that have those designations.

Rick Ferri

[indexnerd]

1% is a standard aum fee because it's what asset managers get away with charging, not because clients "prefer" it.

Get away with charging? Are we talking about sheeple here, or people with brains and choice?

Everything you said in your post could be said of stock investors. You are espousing the same attitude of an active manager/advisor or an active investors: "I know more then the crowd. They're all naive morons, but I'm not."

[HerbertSitz]

Everything you said in your post could be said of stock investors. You are espousing the same attitude of an active manager/advisor or an active investors: "I know more then the crowd. They're all naive morons, but I'm not."

No I'm certainly not saying the average client is a naive moron. I am saying I'm a lot better at judging the quality and cost-effectiveness of a financial advisor than the average client is. I know better than the average client. Sadly, that's not necessarily saying much.

The average client is someone who has little interest in the technical aspects of investing and little interest in learning. They also have little understanding of how the financial services industry works. This isn't because they're naive or because they're morons (to the contrary, they're probably intelligent and successful in their own chosen field), it's because the financial services system itself works against them. The wide variety of adviser business models is confusing for clients, if they're even aware of the differences. The financial industry and media confuse matters further by encouraging investors to think their portfolio should include "hot funds", and that they can "beat the market". It's no wonder why clients are confused.

The average client is not a Boglehead.

I know several advisors who do not have a CFP and are more competent than some that do. In fact, many members of this forum are far more competent than some advisors I have come across that have those designations.

On that note, I recall that Eric Tyson, financial columnist and author of a series of good "for Dummies" books, has a good chapter on questions to ask potential financial advisers in his book "Personal Finance for Dummies". He cautions against placing too much emphasis on the advisor having a CFP, because most advisers with that credential are working as fee-based advisers, taking both commissions and fees. Tyson, like Jonathan Clements, is a financial writer who "gets it". I'll say it a different way: if someone has a CFP and can't figure out that clients are better served by a fee-only arrangement, then they're not worth having as an adviser. Either they don't know enough about investing, or they don't care enough about their clients. Sure, clients should prefer a CFP adviser to a non-CFP adviser, all else being equal. Unfortunately, it's that "all else being equal" part that's the big one.

[indexnerd]

No I'm certainly not saying the average client is a naive moron. I am saying I'm a lot better at judging the quality and cost-effectiveness of a financial advisor than the average client is. I know better than the average client. Sadly, that's not necessarily saying much.

And most active investors and advisors have your same attitude.

The fact is, Herbert, many very smart, very well-educated, very high net-worth clients are more than happy to pay an advisor a fee ranging from .2%-.75% (blended). Are you really implying you're smarter than they are? Are you implying that they haven't read Bogle, Swedroe, Bernstein, and Ferri? Most have (clients of advisors like Ferri, Swedroe, and others who use DFA and Vanguard funds). Maybe, just maybe, you're missing something. Maybe you're really not as smart as you think you are and they're not as dumb as you think they are. It's possible, right?

[larryswedroe]

Just few comments
A) I basically agree with Rick's comments. By deep personal relationship I did not mean be someone's friend. I meant understanding all of the goals, both personal and financial, so that they can be best served.

B) Having a designation guarantees nothing. I don't have anything but an MBA for example--but I have lots of valuable experiences and work with a team many of whom have the designations and skills.

c)Re Herbert, there are plenty of very smart investors who have very high level of knowledge of investing who work with advisors including my own firm. And with that knowledge they also know they can still benefit from the advice of a good financial advisor. And they also know something that almost every advisor would admit to--Advisors are better advisors than they are investors because with their own money emotions can get in the way and they can make mistakes. With someone else's money that is not likely to happen as they are not emotional, purely rational.
And Herbert, Thought you might find this interesting. One of our clients is an ex member of the Federal Reserve. You think he knows a bit about investing?

[HerbertSitz]

The fact is, Herbert, many very smart, very well-educated, very high net-worth clients are more than happy to pay an advisor a fee ranging from .2%-.75% (blended). Are you really implying you're smarter than they are? Are you implying that they haven't read Bogle, Swedroe, Bernstein, and Ferri? Most have (clients of advisors like Ferri, Swedroe, and others who use DFA and Vanguard funds). Maybe, just maybe, you're missing something. Maybe you're really not as smart as you think you are and they're not as dumb as you think they are. It's possible, right?

I'm sure there are many well educated and very smart clients of financial advisors. I wasn't disagreeing with that, in fact didn't I suggest that the average client actually was smart and well educated? I also wasn't implying that I was smarter than they are. What I was saying is that although they're generally smart and successful in their chosen field, the average client has little knowledge of investing and little desire to learn.

I'm sure there are many clients who have read Bogle, Swedroe, Bernstein, and Ferri. But I'm pretty sure the number of these clients are dwarfed by the number of "average" clients who would sooner go to the dentist than study a book on investing.

I'm pretty sure there are a lot of people on the diehards message board who call themselves Bogleheads and who haven't read books by all four of those authors. In any case, as I said, the average client is not a Boglehead. I would assert that the average client doesn't have a big collection of investment books, and while the average client may have read a couple, it's highly unlikely that they've _studied_ them. The odds are also pretty good that they've been exposed to investment books that are actually dangerous to their financial health.

c)Re Herbert, there are plenty of very smart investors who have very high level of knowledge of investing who work with advisors including my own firm. And with that knowledge they also know they can still benefit from the advice of a good financial advisor.. . .

Larry -- No, no, I certainly hope I didn't say anything that implied knowledgeable investors would or should shun financial advisors. I was saying that the average client is probably not very good at picking an advisor because they have little knowledge of investing or the industry. I never meant to imply that a knowledgeable investor would never choose to use a financial advisor. I can think of lots of reasons they would, as you say. And I expect they are good at picking the right adviser for themselves.

[larryswedroe]

Herbert
We are in complete agreement then. And that is also why in my books I give 11 steps to follow for due diligence to help with the process.

[indexnerd]

What I was saying is that although they're generally smart and successful in their chosen field, the average client has little knowledge of investing and little desire to learn.

Yes, you just defined your beloved market. Now apply the same logic to good advisors.

I'm sure there are many clients who have read Bogle, Swedroe, Bernstein, and Ferri. But I'm pretty sure the number of these clients are dwarfed by the number of "average" clients who would sooner go to the dentist than study a book on investing.

Herbert, if you accept that trying to "beat the market" with stock picking is not wise, why are you so sure that you can beat the market on advice? Maybe your going it alone or someone going to a cut-rate advisor is actually costing you/them more and exposing you to greater risk. We have people on this board who pooh pooh a lot of the academic research by FF and others and say it the real world that matters. Yet when you point to how significantly a DFA-based portfolio has done over the past ten years or so vs. a Vanguard-based one, they want to go back to some theoretical argument like the advantage is an anomaly or will disappear or there's some meaningful risk difference. Excuses. The best advisors using DFA funds are using better tools and managing behavior and expectations better than the vast majority of investors do on their own.[/quote]

[HerbertSitz]

Herbert, if you accept that trying to "beat the market" with stock picking is not wise, why are you so sure that you can beat the market on advice?

That's a clever tack to take with the argument, but a specious one. That the markets for securities are efficient surely does not imply that the market for people providing financial advisory services is efficient.

In the stock market (assuming it's efficient) the stocks of "bad" companies are just as attractive as the stocks of "good" companies, even to educated investors. Uneducated investors don't have to have special knowledge to protect themselves against bad companies.

In contrast to that, in the market for advisory services the bad advisors are far less cost-effective than the good advisers. Educated investors will tend to seek out and use only the good advisers. Uneducated investors will try to do that, but fail. Bad advisers will tend to have a higher percentage of uneducated investors as clients than good advisers will.

To say it another way: In an efficient market there are educated investors who trade in every stock and who establish prices that the uneducated can depend on. That's hardly the case in the market for advisor services. Larry has already pointed out questions investors can ask to avoid bad advisors. Educated investors will identify those advisors and stay away from them. Uneducated advisors won't, or if they do ask them, they will not process the answers as well in making a decision. Bad advisors will tend to have higher percentage of uneducated clients and good advisors will tend to have higher percentage of good clients. This is not the case with publicly traded companies. The stocks of bad companies are nevertheless fairly priced and, by definition of an efficient market, are just as attractive to educated investors as good companies are.

The situation in above paragraph exists at least partly because the market for securities is more transparent than the market for financial advisors. The SEC places many very strict requirements on public companies to make their internal information public and holds them accountable for doing so. In addition there are other regulations like prohibitions on insider trading to make sure nobody has an unfair advantage. In contrast, the SEC and the states place relatively few requirements on advisors. As I've already argued earlier in this thread the financial industry is still geared towards confusing investors regarding what's important (e.g., emphasizing recent returns) and on doing their best to hide the fees and expenses being extracted by advisors.

I initially asserted that the average client was poor at choosing a financial advisor in your post that said a 1% advisor fee could be justified because it's what clients were willing to pay. Here's one example of how uneducated investors are morely likely to go wrong:
Assume that there is a bad advisor who charges a 1% aum fee. Bare-bones asset management is the only service he offers and, what's more, he provides it badly. Although he provides his services badly, this adviser is one heck of salesperson. Then there is a good advisor who charges a 1% aum fee. That good advisor provides more than just asset management. That advisor provides all of the services that Larry has described in this thread and does them well. That advisor is not much for making sales pitches, though, doesn't believe in bragging, using "puffery", etc. What happens when an uneducated investor chooses between those two advisors? We've already established that the uneducated investor is more likely to choose the bad advisor than an educated investor would be. The 1% charged by the good advisor may be well-justified. Does that make the 1% charged by the bad advisor justified?

Another example to clarify: While the securities markets may be efficient, the market for mutual funds is not. Even someone who believes in EMT will admit the market for mutual funds is inefficient; they must if they agree that funds with low expenses generally outperform funds with high expenses. Educated investors are more likely to own low expense funds than high expense funds. Uneducated investors are more likely to own funds with high expenses.

[tetractys]

With all due respect, fees are only one side of the table. Do you always buy the cheapest car, eat at the cheapest restaraunt, use the lowest cost accountant, attorney, doctor?

Not always, but most of the time. Over the years I've often found that:

One can maintain a whole fleet of longer lasting used cars for less than the cost of a new car.
Cheap restaurants quite often have the best food, service and ambiance.
Lower cost accountants are often the more honest, thorough and efficient.
Same with attorneys.
The same with doctors! Many of the best work in public health or charge lower fees because they are of the very very few who actually follow the Hippocratic Oath.

Sure you can find examples on all sides of the tracks, but it's only what people end up with in the end that counts. -- Tet

[HerbertSitz]

With all due respect, fees are only one side of the table. Do you always buy the cheapest car, eat at the cheapest restaraunt, use the lowest cost accountant, attorney, doctor?

Not always, but most of the time. . . .

tetractys- Yes yes. I was especially surprised to see Larry include cars and restaurants on that list. Unless you value them as luxury items, then car and restaurant expenses are best minimized. A $10k car does just as well or better at getting you reliably from place to place as an expensive Ferrari. Both cars and restaurants are valued primarily as luxury and status items. For an educated investor luxury and status should not come into the picture at all when choosing a financial advisor.

As a former attorney, I know there are situations when you'd be advised to pay more for a specialist who's really good. This is because the expensive specialist can be more cost effective. There are also situations where an inexpensive general practitioner may be more cost effective (or even outright "better").

In any case, it's cost effectiveness that's important in investing. And unless you value luxury and status, expensive cars and restaurants are virtually never cost-effective. I was curious to see Larry analogizing cars and restaurants to financial advisors. Cost-effectiveness is what you want from an advisor. Luxury and status, not so much, even if you like them in your cars and restaurants.

[larryswedroe]

Herbert
As I said it depends on what you are looking for. Like access to DFA funds is like buying the cheapest import or eating at McDonalds. Buying a Lexus on other hand offers value added to people for variety of reasons, including safety, better sound systems, etc.
So it depends on what you value.
But it was just an analogy, meant to make a point about not always buying the cheapest things. One should always buy based on value perceived for the price paid.

[james22]

A $10k car does just as well or better at getting you reliably from place to place as an expensive Ferrari.

Um, no.

[Bradley]

Herbert
As I said it depends on what you are looking for. Like access to DFA funds is like buying the cheapest import or eating at McDonalds. Buying a Lexus on other hand offers value added to people for variety of reasons, including safety, better sound systems, etc.
So it depends on what you value.
But it was just an analogy, meant to make a point about not always buying the cheapest things. One should always buy based on value perceived for the price paid.

I prefer to buy the Lexus at a discount. That option is available in money management.

Bradley

[larryswedroe]

Bradley
True, but there are even differences in the service quality you get from dealer to dealer--some provide free loaner cars and have much nicer waiting areas, with coffee, etc.

All I am saying is costs are important, but they are not the only thing that matters

And another difference here is that all Lexus's are basically the same whoever you buy them from--but the skills of advisors vary greatly, not just the services they offer vary, but their skills too.