Spurred by this, I decided to check the calculations and run an analysis on my own where the fees are not as high and the return is more in line with what one might expect over the next ten to fifteen years. After checking the Seeking Alpha author figures I found them to be correct. Granted, generating an 8% return over 65 years is quite a feat and fees of 2.5% are definitely on the high side. If the assumptions are more modest, investors handing over their investments to a professional manager are still giving up a sizable chunk of their portfolio over a lifetime of investing.
Here are my assumptions and conclusions.
- Assume an investing life of 45 years instead of 65 years.
- Assume an annualized return of 6% instead of 8%.
- Assume management fees of 70 basis points or 0.7% vs. the high 2.5% used in the Seeking Alpha article.
- Begin with a fixed amount and do not add anything along the way.
Using these assumptions an investor will fork over nearly 26% of their portfolio and the percentage will increase every subsequent year the money is managed by the financial advisor. If the relationship exists for another 20 years the percentage increases to an astounding 35%. That is quite a drag on a portfolio.
Why is it important to control costs. Check out this article using arguments developed by Charles Ellis.
What might an advisor contribute that makes the management fee palatable?
- Advisors can save their clients from making mistakes.
- Although rare, some advisors will add alpha to a portfolio for sustained periods of time.
Take time to go through the math of the Ellis argument as it is a little complicated. Or just pay attention to the conclusions.