Advisor Blog

So, you've decided to work with an advisor that operates under the standard of fiduciary duty and that, consistent with the overwhelming evidence that supports it, chooses to build portfolios based on passive asset class exposure.  So far, so good.

But, even fee-only Registered Investment Advisors offer a bewildering array of services with fee structures that vary widely.  Many appear to offer the same thing for surprisingly low fees that others offer for fees that seem outrageous.

First, decide what type of relationship you want.  Is it bare bones portfolio management - simple asset allocation and rebalancing?  Or, do you want tax management, advanced performance reporting, and complex portfolio design across multiple accounts?  What about wealth management services, like insurance and tax planning, trust administration, or a private banking relationship?  Will the advisor help with your employer's 401(k) and include that in the asset allocation?  Do you need the services of a family office - bill payment, travel arrangement, security services, property management, and/or legal services?

Keep in mind that many small or new advisors may charge fees that are less than the industry average while trying to build their practice.  They may operate out of their home or an executive suite.  They frequently do not have administrative support, in-house compliance programs, sophisticated security systems for the protection of confidential client data, or advanced reporting capabilities.  Are you comfortable with your confidential information residing on someone's home computer or should it be behind a firewall on an encrypted drive in an office that has a monitored security system?  All of these capabilities and safeguards add cost.  But, is it wise to ignore them?

What about the firms that offer a flat retainer fee instead of charging clients based on assets under management?  At first blush, it sounds like a great idea.  But, what is an advisor paid by a flat fee motivated to do?  The only way that that this advisor can increase profitability for his existing account base is to minimize the time spent on each client.  In contrast, the advisor that is paid on assets under management has an incentive to grow each client's portfolio and expand the relationship.  He may be much more willing to spend time with the client in order to do so.

If your primary focus is on portfolio performance, then the yardstick should be the risk adjusted after-fee, after-tax net return of the portfolio.  The advisory fee is actually irrelevant in the comparison of advisors if the risk adjusted net return is higher than that of the competitors.

Many portfolios that provide high expected rates of return are more tilted toward the risk factors that produce return (value and small cap stocks).  But this always comes at the expense of tracking error relative to the common indices (the DJIA, S&P 500, etc) that are talked about on the nightly news or by the CNBC "talking heads" (including clowns like Jim Cramer).  As a result, they require more "hand holding" of clients during the inevitable time periods when the portfolio will underperform the common index that the client uses as a comparison.  These advisors are justified in charging higher fees to compensate them for this activity and for the opportunity cost of lost time developing new clients and growing their practice.

Most prospective clients that engage in "fee shopping" vastly oversimplify the process and tend to choose an advisor for the wrong reason.  Even the fee structures between advisors can be confusing when the services offered are almost identical.  Some advisors that charge based on assets under management use a tiered fee approach and others use breakpoints.  We'll examine the two approaches in the next installment.

Photo by Brian Hillegas