Investment Management Fees Are (Much) Higher Than You Think

[craigr]

Now investing and building a house are obviously two completely different things but you get my point.  Sometimes it is better to pay a professional and save yourself the time, aggravation, and learning the hard way.

The difference is when I hire an electrician to do a job I'm reasonably sure his licensing and credentials will not result in my house burning down. Same for an architect, plumber, carpenter, etc. You can verify their credentials and past house building skills very easily.

With investment advisors there is no guarantee, and no way they could guarantee, that they know what they are doing.

Anyone looking to use an advisor can make the first cut of who knows what they're doing and who doesn't very quickly with this one question:

Do they use passive investing as the core strategy?

If they don't, then I'd have to wonder if the advisor really is there to help or there to sell you stuff.

[MediumTex]

Now investing and building a house are obviously two completely different things but you get my point.  Sometimes it is better to pay a professional and save yourself the time, aggravation, and learning the hard way.

The difference is when I hire an electrician to do a job I'm reasonably sure his licensing and credentials will not result in my house burning down. Same for an architect, plumber, carpenter, etc. You can verify their credentials and past house building skills very easily.

With investment advisors there is no guarantee, and no way they could guarantee, that they know what they are doing.

And "what they are doing" is basically trying to match wits with an anonymous mass of extremely intelligent people and attempting to consistently win.

That's much harder to do than it looks, and that's why people like Warren Buffett are so rare (though every lottery has winners, and these winners can then be used to pull more people into the game).

I normally don't get too far into discussions with investment advisors before it becomes clear that there are a whole constellation of risks and potential outcomes that they have never thought very deeply about.  As the discussion progresses, they often begin to look at me like an illusionist might look at a heckler in the crowd who shouted the secret to each trick before he performed it.

That "look" I am describing is a mixture of extreme annoyance and mild curiosity at how I learned all of his tricks without being an illusionist myself.

To extend the illusionist metaphor a bit farther, most illusionists know that they don't really have real supernatural powers and they are just putting on a show, but some illusionists probably do begin to think that perhaps they do actually have the ability to perform real magic.  I think that many "Master of the Universe" Wall Street-types fall under a similar spell.

In 2008, it was amusing to see so many of these Masters of the Universe wandering around shellshocked, like Superman after eating a Kryptonite-laced candy bar.  I think that they went to the government for bailouts as much to restore their self-images as to rescue their firms.

I do not mean to disparage the hardworking mutual fund salesmen out there who help novices get started in investing.  They do perform a valuable function for someone who doesn't know anything about investing (though these novices often pay dearly for their lack of knowledge).  I suppose it's not unlike a priest who reassures the congregation that comes to him for comfort and meaning in life, even as he harbors a complex set of secret reservations about the framework of beliefs that he offers to others as absolute truth.

In realms in which cause and effect relationships can't be measured, quantified and taught to others, it really pays to educate oneself as much as possible because these are the areas of life where the hucksters, wizards, and con men like to congregate.

Charles Mackay provided many insights into the nature and patterns of human delusion in Extraordinary Popular Delusions and the Madness of Crowds way back in 1841.  In this wonderful book he observed that much of the trickery perpetrated against people throughout history has arisen in response to the following three eternal irritations to the human mind: (i) the inevitability of death, (ii) the unpredictability of the future, and (iii) the dreariness of having to work.

I predict that Charlie McKelvey will say "but none of that stuff describes me", and I'm sure he is telling the truth, but that's sort of like saying that because you locate an honest car salesman it means that the car business is not crooked to its core.  There are good people in the most crooked industries.  Look at Ron Paul.

[moda0306]

If someone believed in solid diversification, understood adequate protection, knew different tax vehicles inside and out, as well as how to take social security, but used managed mutual funds, I think I could handle that last part.  I think it would be very easy to be a very good advisor and still think that there are opportunities out there that either they or a fund manager could identify.

Just a thought.

[dualstow]

I originally started around 1.5 years ago (I was just turning 24 then) with active mutual funds because that is what my father had been using for years. He used things such as Fidelity Contrafund or Low-Price Stock because he's had them for years and low-cost ETFs weren't really around when he started investing in the 80's.

Although Vanguard's 500 Index fund was. Strangely enough, my dad had invested in it for me and my siblings, but never really mentioned it when I first got into stocks. He certainly didn't press. It wasn't until decades later that I found the bogleheads forum and index funds. Without the internet, I probably wouldn't have found their book in the sea of day-trading guides. (I still don't see Craig & Tex' pp book at my local Barnes & Noble; I sought it out at Amazon). When the time came to take control of those index funds that had been set up in my name, I had to laugh. But, maybe it was better to go though the individual stock experience first, and luckily I survived it.

I have to ask: did you try to convert any family members after you got into the permanent portfolio, Greg?

There can be great value in paying someone to teach you. But I believe that there is seldom much value in paying someone to avoid having to learn.

Teach me to fish...

[Greg]

I have to ask: did you try to convert any family members after you got into the permanent portfolio, Greg?

Bought an extra copy of craigr's and MediumTex's book for him to read through for his birthday hah. He's about half-way through it now so we'll see if this changes his thought processes at all. Maybe some day he'll want to hold a gold coin in his hands like I have hah.

[AgAuMoney]

The difference is when I hire an electrician to do a job I'm reasonably sure his licensing and credentials will not result in my house burning down. Same for an architect, plumber, carpenter, etc. You can verify their credentials and past house building skills very easily.

But do you?  And do you verify it with people that actually KNOW, or just look at general complaints or no complaints from people who really are not qualified to judge the work?

Given the experience I have had with multiple electricians, a few carpenters and a couple of plumbers, I think rather than being "reasonably sure his licensing..." it is more like "reasonably comfortable assuming his licensing..."

Because, frankly, everybody in the building trade who's work I've examined has committed blunders causing serious safety, performance or durability problems.  Of all of them, only the electricians causing safety issues have been receptive to me pointing out the problems.  Perhaps because there is a lot less grey area.  Carpenters and plumbers, even for safety and code problems, have always argued that their approach was fine because the inspector allowed it and because people normally redo their _____ in ____ years anyway.  (And in all of these cases I've experienced, the work has been permitted and inspected by the relevant authorities.)

I have to go 100% with Pointed Stick on this one.

Best to learn how to do it yourself, then decide if you want to do it or hire it.  Only then do you know what you are getting.

Anyone looking to use an advisor can make the first cut of who knows what they're doing and who doesn't very quickly with this one question:

Do they use passive investing as the core strategy?

If they don't, then I'd have to wonder if the advisor really is there to help or there to sell you stuff.

I'd rather start with understanding how they get paid and go from there to understanding their strategy based upon my own knowledge.  If they try to baffle me, I'll play the part and take them for everything they are willing to give.  I've gotten 3 very nice dinners for two from a local advisor...

[rocketdog]

Sorry but that article is just ridiculous.  I follow the logic he presents with trying to build a case that active management fees are high.  Based on that however, we should all invest in some index fund at Vanguard.

If not at Vanguard, then somewhere else where we can keep our fees down (for me that's Schwab).  And the only thing ridiculous about the article is that so many people still think active managers can consistently outperform their benchmarks, even though study after study has shown that to be a fallacy. 

That is actually the philosophy of a lot of people which seems to work just fine in up-years, until a 2008/2009 happens and you lose over 50% of your total assets in your passively managed index fund.  Are you still so happy about paying nothing in fees?  Wouldn't it have been better to have someone on your retirement castle wall to move your assets to safety?

This is precisely the mentality that gets people into trouble, thinking they can "foresee" the future direction of the market.  Active managers have no better idea than anyone else as to where the market will be tomorrow, or next week, or next month, or next year. 

The bottom line is that the research is loud and clear:  active managers do not bring the expected added value to their clients after all loads, fees, commissions, taxes, and expenses have been factored in. 

[rocketdog]

Many times these clients come from Vanguard or large banks and invest their entire portfolio in index funds due to the miniscule operating expense.  They then set the portfolio in cruise control and go about their daily lives.  Enter 2008/2009...

"Index funds" do not equal "diversification".

Anyone who was so heavily invested in the stock market in 2008/2009 that they were financially devastated clearly is in need of professional investing advice.  But that should not be taken as a slight against low-cost index funds themselves.  These are just tools, and like any tool if wielded properly they can be used to build, but if wielded improperly they can be used to destroy. 

[rocketdog]

One more thought on this topic...

I arrived here at this forum by way of educating myself.  I had always done my own investing in my 401K, then right when the 2008 meltdown hit my wife and I hired a NAPFA financial advisor to handle our retirement accounts (which at that point also consisted of Rollover IRAs and Roth IRAs). 

In hindsight, he did fine: not stellar, not terrible.  We used his advice in several other areas such as tax planning and buying a new house.  So that was certainly useful and I'd consider using his services again in that regard. 

During the 3 years we were with him, I read every book on investing I could get my hands on at the library.  I even read research papers about investing.  It all eventually lead me to the conclusion that we were best off holding well-diversified index funds as the bulk of our portfolio. 

To prove to myself I could do as well as our advisor, I set up a "fantasy" account on Yahoo! Finance.  I then tracked my performance against his for the next year, at the end of which we were essentially neck-and-neck.  In fact, we had been neck-and-neck for most of the year, except that we were paying him 1% of AUM to do what I was doing for free.  Plus he wasn't using passive index funds like I was. 

Eventually I showed my wife my results, and we decided to save the AUM fee by taking back control of our money.  I continue to read about investing and I haven't looked back since. 

[l82start]

autodidact is a  regenerative chronic condition, that causes your investment and your understanding of investing to grow for the rest of your life... 

[BearBones]

autodidact is a  regenerative chronic condition, that causes your investment and your understanding of investing to grow for the rest of your life...

I can find things in all of our lives that we could do but we don't, either because it is more productive to spend time elsewhere of because it is not enjoyable. IMO, just because everyone here is smart and interested in do-it-yourself investing does not mean that we should extrapolate this to everyone else in the world.

I can learn to remodel my kitchen. But I would have to give up a lot of income to take the time to read about it, buy the materials, and do the work. And I would not enjoy it! Ditto for car repairs, legal work, producing your own food, etc.

[MediumTex]

autodidact is a  regenerative chronic condition, that causes your investment and your understanding of investing to grow for the rest of your life...

I can find things in all of our lives that we could do but we don't, either because it is more productive to spend time elsewhere of because it is not enjoyable. IMO, just because everyone here is smart and interested in do-it-yourself investing does not mean that we should extrapolate this to everyone else in the world.

I can learn to remodel my kitchen. But I would have to give up a lot of income to take the time to read about it, buy the materials, and do the work. And I would not enjoy it! Ditto for car repairs, legal work, producing your own food, etc.

With some things there is an "amateur's joy" that can make a topic a delight to learn about, often in greater detail than  professionals who get jaded from the constraints involved in trying to make a living.

I enjoy the topic of investing far more than I probably would if it's what I did for a living.

[l82start]

I can find things in all of our lives that we could do but we don't, either because it is more productive to spend time elsewhere of because it is not enjoyable. IMO, just because everyone here is smart and interested in do-it-yourself investing does not mean that we should extrapolate this to everyone else in the world.

I can learn to remodel my kitchen. But I would have to give up a lot of income to take the time to read about it, buy the materials, and do the work. And I would not enjoy it! Ditto for car repairs, legal work, producing your own food, etc.

no it doesn't apply to every aspect of your life even if you could apply it, or to every person in the world, but it is a bit like a bug you catch.. once you discover you can do it, its hard to go back, some things especially investing (in my opinion) have a pretty high reward for a small amount of effort, other things may not catch your interest or be worth the time and expense. but once you know you are capable of being "self taught" it changes how you make those decisions about where to focus your time and efforts, you may not want to become a "car guy" but you have the option to learn enough to keep some mechanic from selling you an expensive "flux-capacitor", the things done by professionals are no longer "incomprehensible magic"

[rocketdog]

IMO, just because everyone here is smart and interested in do-it-yourself investing does not mean that we should extrapolate this to everyone else in the world.

But that's just it -- you don't need to commit lots of time to learn how to invest (even though I did, but that's just me).  In fact, once you get the "gist" of it, you can do quite handily by only checking up on your investments a few times per year and rebalancing as needed. 

I think investing a few months of your life up-front to educate yourself on the topic and then getting your financial affairs in order is a wise investment indeed. 

[Pointedstick]

IMO, just because everyone here is smart and interested in do-it-yourself investing does not mean that we should extrapolate this to everyone else in the world.

But that's just it -- you don't need to commit lots of time to learn how to invest (even though I did, but that's just me).  In fact, once you get the "gist" of it, you can do quite handily by only checking up on your investments a few times per year and rebalancing as needed. 

I think investing a few months of your life up-front to educate yourself on the topic and then getting your financial affairs in order is a wise investment indeed.

Indeed. Even a fairly simple portfolio of VTI, TLT, IAU, and SHV/Y is light-years ahead of 99.9% of everyone else. Sure, you don't get the full PP protection, but it beats the hell out of paying a manager 1% to invest your money in something far worse than the PP anyway.

The 80/20 rule probably applies here, so most of the benefits of DIY'ing any subject are gained pretty quickly.

[craigr]

I completely agree that a lot (most?) people are not interested or are scared about managing their own investments. They feel they need a money manager and don't know what questions to ask that money manager before turning over their life savings. I see it a lot just in casual conversations when people find out I write about this topic.

They immediately want to know stuff like:

1) What is the market going to do?
2) What's the best fund for them to own now?
3) Do I have any good stock tips?
4) What do you think about investing guru X and his latest prediction?

Etc.

So there is this baseline of knowledge that is not very good and is enhanced by sources like CNBC, Money Magazine, etc. And, frankly, a lot of money managers I've met believe a ton of this stuff as well (or worse). And those money managers dominate the market so that's what people end up using.

And the thing is you get new money managers each day coming online that are taught and believe this stuff as well. Many of them think they can beat the market, choose hot funds, etc. It's ego and ignorance poised to strike.

Given the above, if someone tells me they are a money manager they immediately are guilty until proven innocent. And by innocent I mean:

1) They should be using passively managed investing.
2) They should be focusing on controlling costs.
3) They should be widely diversified and not tinkering with things after setup.

And if they don't understand those three things at a minimum, I would avoid using that person for money management.

One last thing about all of this because it really applies to a lot of money managers that are picking actively managed funds for their clients. It's this:

They are adding in a layer of abstraction onto a layer of abstraction. Consider:

1) Out of thousands of funds the money manager is going to pick the winning fund manager.
2) The fund manager is then going to use whatever strategy to pick a winning allocation.
3) The fund manager can change course at any time in many cases and do whatever they feel like doing.

So if the odds of an individual picking a group of stocks to beat the market is small over time, what are the odds of picking a fund manager that will then pick those winning stocks? I'd say pretty bad.

There is zero evidence to suggest that active money management works. People can find anecdotes all day long, but the long term results of consistent returns for the average investor just aren't there.

Not everyone can be above average, but that's exactly what the actively managed fund crowd advertises.

[rocketdog]

With some things there is an "amateur's joy" that can make a topic a delight to learn about, often in greater detail than  professionals who get jaded from the constraints involved in trying to make a living.

I enjoy the topic of investing far more than I probably would if it's what I did for a living.

Excellent observation.  And it's true, probably because when it's a "hobby" you have no external pressures or expectations from others bearing down on you.  If you enjoy, say, painting art in your free time, it's something you can do whenever you want, to whatever extent you want.  You don't even care if anybody else likes your work.  But if you had to make your living as an artist, suddenly you have to worry about finding clients, meeting deadlines, collecting payments, and all the other trappings of a "business". 

[Pointedstick]

With some things there is an "amateur's joy" that can make a topic a delight to learn about, often in greater detail than  professionals who get jaded from the constraints involved in trying to make a living.

I enjoy the topic of investing far more than I probably would if it's what I did for a living.

Excellent observation.  And it's true, probably because when it's a "hobby" you have no external pressures or expectations from others bearing down on you.  If you enjoy, say, painting art in your free time, it's something you can do whenever you want, to whatever extent you want.  You don't even care if anybody else likes your work.  But if you had to make your living as an artist, suddenly you have to worry about finding clients, meeting deadlines, collecting payments, and all the other trappings of a "business".

Although that can be rewarding too, as long as you have an interest in commerce. Sadly, it seems that most artists don't.

[moda0306]

Not everyone can be above average, but that's exactly what the actively managed fund crowd advertises.

Aren't they really advertising that it is THEM that is above average?

I agree that there are many tricks and accidents that can be used as "evidence" of this by the market-timers, but is it ONLY luck that differentiates them?  I have to think that not all managed funds are created equal, and some financial advisors spend a decent amount of their time trying to sort out the meaningful differences.

Of course this leaves us wondering whether OUR advisor is one of the good ones.  However, I think treating it all like it's impossible I think is a bit of a stretch.  I mean even you identified that the Euro was destined for failure the minute you saw the arrangement.  MT saw deflation and lower LT bond rates.  Personally, I'd trust both of you to manage some of my money if I hated doing it.

[Pointedstick]

Not everyone can be above average, but that's exactly what the actively managed fund crowd advertises.

Aren't they really advertising that it is THEM that is above average?

I agree that there are many tricks and accidents that can be used as "evidence" of this by the market-timers, but is it ONLY luck that differentiates them?  I have to think that not all managed funds are created equal, and some financial advisors spend a decent amount of their time trying to sort out the meaningful differences.

Of course this leaves us wondering whether OUR advisor is one of the good ones.  However, I think treating it all like it's impossible I think is a bit of a stretch.  I mean even you identified that the Euro was destined for failure the minute you saw the arrangement.  MT saw deflation and lower LT bond rates.  Personally, I'd trust both of you to manage some of my money if I hated doing it.

Right, clearly some managers are above average. That's how there is an average. The problem is how you as an investor choose one of them. If you couldn't choose above average stocks, how are you supposed to choose an above-average money manager? At best, you've just exchanged one problem for another. At worst, you've added another problem.

I would trust MT or Craig too, but I only know them because I'm here on this DIY investment forum, and once I learned enough about the PP, I could just implement it myself…

[rocketdog]

Aren't they really advertising that it is THEM that is above average?

Precisely.  But we don't live in Lake Wobegon so it isn't possible for all of them to be above average. 

I agree that there are many tricks and accidents that can be used as "evidence" of this by the market-timers, but is it ONLY luck that differentiates them? 

No, but what differentiates them is irrelevant because you have no way of knowing in advance which advisors might be more than just "lucky" over the next X number of years. 

I mean even you identified that the Euro was destined for failure the minute you saw the arrangement.

Don't forget that the Euro nearly doubled in value against the dollar from 2001-2008. 

[MachineGhost]

Right, clearly some managers are above average. That's how there is an average. The problem is how you as an investor choose one of them. If you couldn't choose above average stocks, how are you supposed to choose an above-average money manager? At best, you've just exchanged one problem for another. At worst, you've added another problem.

The retail muppets have no access anyway.  All of the long-term successes on Wall Street (i.e. two or three handfuls of hedge funds) were self-taught more or less back in the beginning.  So unless you're a PhD or magna cum laude from Ivy League and get invited as an employee, or have intergenerational family connections, you're SOL.  The only realistic option is to learn it all yourself, which fortunately, decentralized technology and automation is increasingly good at providing.

[amp]

Although I don't believe in active management, I do think that SOME people could benefit from having a financial advisor just to keep them from doing something stupid... like trying to time the markets.

A long time ago I read something about the difference between investment returns and actual investor returns and the gap was multiple percentage points (5+% per year if I recall).  If having someone tell you that your fears are valid (but you should stay the course) or that you shouldn't chase fund performance or that you have no business buying into a hedge fund, I'm thinking that could benefit you by more than 1% per year.

Now, I don't know if such an advisor exists that would put you in the PP and keep you on it forever, but I do think it could help those folks that get distracted easily.

[rocketdog]

Although I don't believe in active management, I do think that SOME people could benefit from having a financial advisor just to keep them from doing something stupid... like trying to time the markets.

Absolutely.  Some people are their own worst enemy.  It's all too easy to fall into that trap these days, what with the bombardment of investing infirmation being hurled at us from every direction (TV, radio, newspaper, Internet).

But once you've latched onto your lifelong financial plan and committed yourself to it, everything else just seems to fall away and go quiet.  To paraphrase Rudyard Kipling:

[align=center]If you can keep your head when all about you are losing theirs
Yours is the Earth and everything that's in it[/align]