The true price of financial advice

Many people worry about running out of money in retirement and some work longer than they would like to avoid such a possibility. Others take on part-time work after officially retiring to make ends meet.

It might be possible to avoid slaving away by learning how to manage money more efficiently. Those who do might save more than they’d earn by working a part-time—or even a full-time—job after retirement.

Unfortunately, many investors have no idea of how much they pay for financial advice. Now, due to new disclosure requirements, known as CRM2 as the latest iteration of the Client Relationship Model, Canadians will be confronted with the cost on their brokerage statements. Expressed clearly in dollars, it’ll come as a shock to many.

To be clear, good advice can be worth paying for and investors who are just starting out should always consult an advisor. But the prices vary and the value can decrease for experienced investors.

When thinking about fees, it’s useful to break the advice business down into two parts. Front-line advisors provide individualized asset allocation, retirement planning, tax planning and similar services. They also typically recommend a portfolio of funds. The second layer of advice comes from the fund companies, which hire portfolio managers to actually pick stocks and bonds. It’s common for both services to be bundled together with the combined annual cost ranging between 2.0% and 2.5% of assets under management.

While a 2.0% to 2.5% annual fee on assets doesn’t sound like much, it’s quite large in comparison to conservative estimates of what the market is likely to return over the next decade, which is about 4% annually on a balanced portfolio.

It’s also useful to convert percentage fees into dollars terms. The accompanying table does just that based on different portfolio sizes and percentage fees. You’ll notice that a small 2.5% fee on a million-dollar portfolio cost a whopping $25,000 a year.

To put that in perspective, the minimum wage in Ontario will climb to $11.40 per hour this year. Sturdy retirees who are willing to work 40 hours a week for 52 weeks a year for minimum wage will make $23,713 before taxes. Alternatively, if they can slash their investment-related expenses, they might be able to save more than they’d earn, after tax.

The good news is there are several ways to cut fees, some without cutting out an advisor. Broadly speaking there are three ways to do it. You can keep the individualized advice but move to a portfolio of low-fee funds. Or you can opt to do your own planning and choose a low-fee portfolio of professionally managed funds. Finally, those with sufficient knowledge and experience can do it on their own and cut costs to the bone.

Let’s take it a step at a time

Many advisors are happy to charge about 1.0% annually on assets under management for their services. A few are pleased to steer clients to portfolios of simple, low-fee index funds. In such cases, the cost for the bundle might fall to about 1.25% annually. That’s half the cost of a 2.5% annual fee and it slashes the fee on a million-dollar portfolio from $25,000 to $12,500. While $12,500 is still a good deal of money, the advice might be worth it, simply to ensure you are not making a big financial mistake. It also comes with the sort of personalized service, planning and hand holding during hard times that some investors sorely need.

Or you can work with fund companies directly for portfolio advice, and invest in their funds. Steadyhand Investment Funds and others provide this sort of service. Their advisors develop customized portfolios with an all-in cost of roughly 1%, a savings of about $15,000 a year on the 2.5% option.

The ultimate cost saver—for those with the experience and knowledge—is to do it yourself. Those who opt for a simple low-cost portfolio of exchange-traded funds like the MoneySense Global Couch Potato portfolio can slash costs to about 0.25%, or lower. That saves an investor about $22,500 a year, based on the same scenario, which is the equivalent of a full-time minimum-wage job. Pick the path that is right for you. For my part, I’d rather cut the fees.