Investment Help

If you are seeking investment help, look at the video here on my services. If you are seeking a different approach to managing your assets, you have landed at the right spot. I am a fee-only advisor registered in the State of Maryland, charge less than half the going rate for investment management, and seek to teach individuals how to manage their own assets using low-cost indexed exchange traded funds. Please call or email me if interested in further details. My website is at http://www.rwinvestmentstrategies.com. If you are new to investing, take a look at the "DIY Investor Newbie" posts here by typing "newbie" in the search box above to the left. These take you through the basics of what you need to know in getting started on doing your own investing.

Tuesday, April 26, 2011

What is the Cost of Investment Management?

I teach people how to manage their assets. Why? Because I feel people overpay for investment services and generally get poor service. You have to understand this going in. I'm biased on what I'm about to present.

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:

Source: BlackRock
CLICK TO ENLARGE Granted there are many paths we could have gone down but this is one path we did travel. It seems that every time I look at this chart I learn something new. It shows the value of diversifying, why not to chase hot sectors, and the biggest ups and downs of the past 20 years. It also gives us what we need to calculate the cost of investment management. But first, let's backup and visualize what we are considering.

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:



YEAR PORTFOLIO  RETURN YEAR END FEE VALUE 2009
1990 1,000,000             0.97 970,000 9,700 47096.0173
1991 960,300 1.262 1211898.6 12,119 46625.0572
1992 1,199,780 1.075 1289763.09 12,898 46158.8066
1993 1,276,865 1.133 1446688.56 14,467 45697.2185
1994 1,432,222 0.997 1427925.01 14,279 45240.2463
1995 1,413,646 1.274 1800984.7 18,010 44787.8439
1996 1,782,975 1.136 2025459.43 20,255 44339.9654
1997 2,005,205 1.206 2418277.03 24,183 43896.5658
1998 2,394,094 1.17 2801090.29 28,011 43457.6001
1999 2,773,079 1.137 3152991.26 31,530 43023.0241
2000 3,121,461 0.989 3087125.27 30,871 42592.7939
2001 3,056,254 0.952 2909553.82 29,096 42166.8659
2002 2,880,458 0.902 2598173.37 25,982 41745.1973
2003 2,572,192 1.235 3176656.68 31,767 41327.7453
2004 3,144,890 1.105 3475103.57 34,751 40914.4679
2005 3,440,353 1.054 3626131.57 36,261 40505.3232
2006 3,589,870 1.13 4056553.39 40,566 40100.2699
2007 4,015,988 1.06 4256947.13 42,569 39699.2672
2008 4,214,378 0.772 3253499.55 32,535 39302.2746
2009 3,220,965 1.208 3890925.18 38,909 38,909

6.02%

528,757 857585.55

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.

4 comments:

  1. No wonder none of the customers have yachts.

    Is that 1-2% on top of the fees charged by the managers of whatever investments your financial manager places you in?

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  2. I am just waiting for the "counterattack" from all the wealth managers out there as they are being hammered on costs on multiple websites. There's too much "easy money" at stake for them to ignore this rhetoric...yet cyberspace remains silent...

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  3. @ The Grouch You hit the nail on the head. How many jobs can you think of where you get a 20% raise for something that has nothing to do with how you have performed?
    @Mich Wealth managers won't counter attack. First of all they have no argument and most of their clients have no clue of what they are giving up.

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  4. Wow! This is a great post Robert.

    And you're right about there not being a likely counter-attack. What can they say? Very little, if anything.

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