We discussed the various ways that fees are charged when you invest and receive financial advice in Part I of our series.  Today we are going to talk about their impact and ways to make sure you are getting good value for what you pay.

The Impact of Fees

Consider a young couple who begins investing for retirement at the start of their marriage.  Assume the following:

• They start with $0 invested for retirement
• They contribute a total of $1,000 per month to their retirement accounts
• Their accounts earn 8% per year
• They make contributions every month for 40 years and then retire

Using these assumptions, this couple will contribute a total of $480K to their accounts but their portfolio will grow to nearly $3.5M by the time they retire.  However, depending on the fees they pay, they could end up keeping less than half this amount!

Whether or not the ending balances shown above allow our hypothetical couple to achieve their retirement goal is irrelevant for this conversation.  This example illustrates a simple truth: Fees can have a substantial impact, so be efficient with your costs and make sure you get good value.

What’s Good Value?

You may recall from Part I of this series that fees come in many forms and they often overlap each other.  For instance, investing in your workplace retirement plan usually results in the payment of administrative fees, but you will pay fees in the form of expense ratios to the funds you invest in as well.  It would not be unusual to pay a total cost of 1.50% or more per year between administrative fees and expense ratios if you work for a mid-sized company.  This cost exists even though you are not likely to receive help constructing your portfolio or planning your retirement.  The value you do receive is access to a retirement account with a high contribution limit, an employer match, and some diversified investment options from which to choose.

For comparison, consider a financial advisor who charges a 1.50% fee for advisory services and uses cost-efficient securities to build portfolios.  For a cost similar to your 401K, the advisor will research different investment options and help you select an appropriate asset allocation.  Asset allocation matters because it is the most important determiner of the risk and returns you can expect in your investment accounts over time.  Moreover, by managing the account on your behalf, an advisor can keep you from making ad-hoc changes that would negatively impact your long-term performance.

If the advisor also includes financial planning as part of their fee, then you may receive a suite of services that can help you better manage your income and expenses, evaluate your employee benefits and insurance coverages, develop debt repayment strategies, invest for your children’s college education, minimize the taxes you pay, and also plan for your retirement and long-term care.

From this perspective, the benefits of working with a financial advisor are substantially more valuable when compared to what might be received by paying a similar rate in a company-sponsored retirement plan.

What To Look For?

If you’re not going to attempt to DIY your investment management and financial planning, look for an advisor that:

• Is Fee-Only
• Uses and recommends cost-efficient securities to build investment portfolios
• Offers services that match your needs

Fee-only advisors are fiduciaries, meaning they are required by law to act in the best interest of the people they serve and they are only permitted to receive compensation from their clients.  This may sound strange, but there are many types of financial professionals who are permitted to collect fees from you while also being compensated by the companies they represent.  This creates a conflict of interest.  If you’re paying a commission or a load to a financial professional, you are working with someone that is not fee-only or required to make recommendations that are in your best interest.

Additionally, seek out advisors that build their portfolios using investment options that have expense ratios of less than 0.25%.  Securities that fit this description generally include index funds and ETFs, and advisors can build portfolios with individual stocks or bonds and avoid expense ratios altogether.  Advisors who use low-cost securities will also help you to select similar investments from those available to you through your workplace retirement plan.

Finally, look for an advisor who offers services that match your needs.  As explained in Part I of this series, some financial advisors limit their services to investment management only and offer little to no help to clients who have financial planning needs.  If you want help in both areas, work with an advisor who does both and says so in their ADV Brochure.