Tuesday, November 24, 2009

Are Financial Advisors Worth 1% of Your Savings Each Year?

The recent introduction by of mutual funds that hold a single ETF and pay financial advisors 1% trailers each year for selling these funds has stirred a debate: are financial advisors worth 1% of your savings each year? Of course, the answer depends on the investor and financial advisor.

Knowledgeable investors won’t find it worthwhile to pay anyone 1% of their assets for financial advice every year. Poor financial advisors aren’t worth 1% each year no matter how little the investors know about investing. But what about the combination of investors with medium to low knowledge and advisors who are middling to very good?

People differ on this question, and I don’t have the data to answer it definitively. However, I can examine my own experience. When I first began investing in more than bank GICs, I turned to a financial advisor who gave a presentation at my workplace.

For about 5 years I owned mutual funds recommended by this advisor. For two years during this period I owned more mutual funds sold to me by another advisor. If we assume that these advisors collected 1% of my savings each year, then they got a total of $2781 (in present-day dollars) from me. Of course, I paid more than double this in MERs, commissions, and deferred sales charges, but let’s assume that just 1% went to the advisor.

For this $2781, I estimate that over the 5 years I took up about 5 hours of these advisors’ time either speaking to them in person or on the telephone. No doubt these advisors spent more time doing things not visible to me behind the scenes related to my accounts.

About half of this time was spent on a brief initial interview to collect information about me and a few brief meetings where I handed over more money to place in my accounts. The other half was spent in a few meetings where they tried to convince me to borrow money to invest more.

One advisor convinced me to borrow enough to use up all my available RRSP room. The other failed to convince me to take out a big mortgage on my nearly-paid-for home. The RRSP loan worked out well because I managed to pay it off in one year. Taking out a mortgage would have been a disaster because the stock market tanked shortly afterward.

Throughout this period, I was pretty naive about investing (but was learning on my own). I should have been a good candidate for getting help from a financial advisor, but it seems clear to me that the “help” I got was not worth the $2781 I paid.

My experience is just one data point. I’ve met investors who are happy with their advisors and others who are unhappy. However, I’d like to see investors figure out how much they’ve paid their advisors and then decide if the money was worth it.


  1. Great question in post title.

    Easy answer: NO

    "...meetings where they tried to convince me to borrow money to invest more."

    The despicableness of this is beyond words. They need you to borrow unnecessarily to pay then more fees.

    Fiduciary? No even close.

  2. How many investors don't even know they are paying their advisor? Some may not know how their advisor makes their money, and might assume they are getting paid a salary by whatever firm they work for, instead of living mostly on the commisions and fees they create from the specific customers. I'd be surprised if this percentage of investors was less than 10%.

  3. Mark: I'm inclined to agree with you, at least for my experience. There must be others who have been helped by their advisors. Unfortunately, the few people I've talked to who say they like their advisors summarize why they like them by saying something like "he's a great guy" rather than providing concrete evidence that the advisor has done a good job.

    Big Cajun Man: You're probably right that many investors don't know how their advisor gets paid. I guess the first step is knowing that your advisor gets paid out of your savings. The next step is to figure out how much.

  4. CC: Good point. A model where fees are a fixed dollar amount plus a small percentage of assets makes more sense to me. Something like $500+0.1% in the first year, and another $200+0.1% in subsequent years might make more sense. The fixed dollar amounts would vary based on the skills and services of the advisor. The percentage of assets should be based on real costs. For example, if advisors have greater liability for larger portfolios, it makes sense to pass that cost on to clients.

    1. The comment above is a reply to Canadian Capitalist's comment:

      If a financial advisor provides competent service, 1% of portfolio might be cheap for someone with just $10K but too expensive for someone with $1M. I think financial plans should cost a flat initial fee and a modest annual update fee.

  5. I completely agree! Over 30 years of investing that 1% could make a lot of retirement dreams come true.

    Plus, there is a great personal power that comes when you control your own financial destiny. It seems that we take ownership of every other important area of our own lives but hand finance over to strangers.


  6. Doctor Stock: Here's hoping that your performance keeps up so that you don't have to fire yourself :-)

    Dave: You're right. Over 30 years, taking 1% per year leaves a portfolio 26% smaller.

    Michael: An open and honest relationship with a FA is a great start, but it's not enough. FAs needs to be saving investors at least 1% per year to make up for their fees. This is certainly possible for investors who otherwise would make serious mistakes. The problem is that investors likely to make mistakes are also likely to be unable to judge whether their FAs are doing a good job.

    1. The first reply above is to Doctor Stock's comment:

      Generally, No. And, the majority of Canadians are moving away from using financial advisors and are doing it on their own... for at least part of their portfolio.

      When I made more than my professional advisor on a regular basis with my portfolio, I decided to fire him and hire myself full time :).

  7. There are two other issues here.

    The first is that people don't know exactly how much in trailers their advisors are getting. Most advisors will just say that you don't have to pay them anything.

    The second is that you aren't paying them 1%, the mutual fund company is. It makes it hard to negociate rates with either.

    The reality is that the system works. People that wouldn't pay $100 for an advisor or invest in stocks end up doing both. To really negociate the 1% fee, you need a better system that works. Fee-only doesn't seem to be catching. The same people that pay thousands in MER fees will balk at paying $100 up front.

  8. Aolis: I was with you until you said that the system works. I'm not convinced of this. Even if we take your premise that people need to invest in stocks and wouldn't unless we trick them into thinking that there are no fees, it's not clear that they are better off than if they just bought bank GICs. Let's look at a typical Canadian investor in mutual funds who is 50% in stocks and 50% in bonds and paying a 2.5% MER. This investor is bearing all the risks of stock and bond ownership, yet is giving away a large chunk of the risk premium. Many such investors may be better off with the GICs. My preference would be a system that properly discloses fees. If some investors then choose not to invest in mutual funds, so be it.

  9. Absolutely! After years of paying an average of 2.5% MER's I finally decided to fire my advisor/2 faced friend. I now manage (conservatively) my investments through an online brokerage account at $9.99/trade and my portfolio is up 10% in only 10 months in a very volatile 2011 market. One of the best decisions of my life as I now see the world much differently. Its terrible that so many don't realize how important this is...

  10. What about the tax consequence of cashing out your mutual funds if they are in a RRSP? I am considering trying to do things on my own but I'm concerned about early redemption fees and tax consequences.

  11. If I cash out all my mutual funds will I not incur early redemption fees and what about the tax implications if they are in a RRSP?

    1. @Billy: It depends on how you do the cashing out. If you sell your mutual funds and leave the cash in the RRSP and then do a proper RRSP transfer to another RRSP account, then there are no tax implications. Usually, it is best to talk to the institution that will be receiving the transfer to make sure you do this properly.