For some people all of this investment stuff doesn't matter. They say they are happy with their investment advisor. Then they turn around and rant about how they don't have enough to retire. This is worth thinking about as you view the following.
A third point to keep in mind is that financial planning and investment management are two different endeavors. You could get a sophisticated financial plan done by a financial planner and then have the assets turned over to Warren Buffett to manage. Again, they are separate functions. There is considerable confusion on this topic in the blogosphere. Let me be clear: for many people, a well done financial plan is worth paying for and, in fact, I've seen costly financial plans pay for themselves as the planner spots an attractive tax savings etc.
What we are going to look at is solely investment management. Specifically we'll think about how much could be saved managing your own assets. What we'll find is that the savings are huge - this isn't the old "change your own oil" tactic from graduate school days. This is meaningful savings. It is the difference between being able able to retire comfortably and not.
Regular readers of this blog know I like periodic tables of investment returns and especially the Table put out by BlackRock for the 20 year period ended 2009 shown here:
Google "wealth mangers" along with your zip code and you'll find at least 10 wealth managers within 25 miles, say, of where you live unless you're in the Amazon jungle or the North Pole. Call the 10 wealth managers and tell them you have $1.0 million in assets and you need help managing it.
To make a long story short they will gladly manage it for you at a fee of between 1% and 2% of the market value of assets. Thus, the first year fee on your $1.0 million will be approximately $10,000.
The question we are interested in is the cost of professional management if we had gone back 20 years ago to 1990. What would have been the impact on the portfolio of professional management at 1% versus managing it ourselves? Keep in mind that assets typically need to be managed over much longer periods so we are actually looking at a short time frame - maybe someone in their mid 40s with a couple of rollover IRAs and 20 years to retirement.
This is not the place to point out that professionals, after fees, underperform markets over the long term. If you need evidence of this please do not hesitate to contact me. We are going to assume that the investment manager achieves the returns of the diversified portfolio in the BlackRock table.
We'll also assume that the investment manager gets paid at the end of the year. In the real world investment managers are paid at least quarterly.
Using the returns provided by BlackRock produces the following results for our little experiment:
Let me go through the first couple of rows before we focus on the results. As stated, we start with $1.0 million. In 1990, as shown on the BlackRock chart (white box) the diversified portfolio was down 3%. The portfolio in the table therefore has a "Year End" value of $970,000. The manager receives a 1% fee of $9,700. In 1991 the portfolio starts at $970,000 minus the fee of $9,700, or at $960,300. In 1991 the diversified portfolio earned a return of 26.2% etc. etc.
The last column needs explaining. If you were managing the diversified portfolio yourself, and not paying a fee, the $9,700 fee would have remained in the portfolio and obtained the returns experienced over the subsequent 20 years. In other words, the $9,700 would have grown to $47,906. The column showns what each fee would have grown to, given the subsequent returns!
The column totals show that fees amount to $528,757 and the total of what their value would have been if they remained in the portfolio amounted to $857,585!
There are other interesting results. First, after fees the portfolio increased to $3.2 million and had an average annual return of 6.02%. Many would feel like their manager had done a good job. Plus, trust me, in this instance the manager would present it as good performance - that's the true talent of many of them. The portfolio itself achieved a return in excess of 8%.
It is important to understand how conservative this experiment has been. Nothing has been said about load fees, commissioned product or trading costs etc.
My contention is that it is not that difficult for the client in today's world of low cost indexed ETFs to capture much of that $857,585!
Disclosure: This post is intended solely for educational purposes. Individuals should do their own analysis and/or consult with an advisor before investing.