This post is an update of a post published 4/26/2011. It looks at market performance from the perspective of investment management cost over 20 years from 1/1/1993 to 2012. The previous post covered 20 years ended 12/31/2009.
If you are a typical investor using an investment advisor, you probably have wondered at some point exactly what it is costing. On the surface, it looks rather small - the typical advisor charges between 1% and 2% of the market value of assets managed.
Throw into the mix, however, the mountains of evidence which show that, over the long run, 3 out of 4 managers who try to beat the market and charge high fees for their services underperform--and the question becomes really interesting.
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 profitable attractive tax savings, etc.
What we are looking at here is solely investment management. Specifically, we'll think about how much could be saved managing your own assets and just matching market performance. Bottom line: 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 to retire comfortably and not.
Regular readers of this blog know I like periodic tables of investment returns because they readily enable analyses of this type. Here is the link to the Table put out by BlackRock for the 20-year period ended 2012:
CLICK TO ENLARGE Granted there are many paths we could have gone down over the past 20 years, but this is one path we did travel. The table shows the value of diversifying, why not to chase hot sectors, and the biggest ups and downs of the past 20 years. It also shows the performance of a diversified portfolio (white box) and, thereby, gives us what we need to calculate the cost of investment management for a basic diversified portfolio. But first, let's back up and review what we are considering.
Google "wealth managers" 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 1993. 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 for someone in their mid-40s with a couple of rollover IRAs and 20 years to retirement.
Again, most professionals (and individuals who try to pick stocks and time the market), after fees, underperform markets over the long term. If you need evidence of this, please do not hesitate to contact me. For our analysis, we 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 :
If you can need some practice, work through 1998 which saw the largest drop in the market.
The totals are what we are interested in. Over the 20-year period, $386,917 went in to the pockets of the investment manager. If, instead, the yearly amounts had remained in the portfolio and achieved the ensuing market returns, the total amounts to $836,196! No wonder Fred Schwed stood on the docks at the end of Wall Street looking at the broker yachts and wondered where the customer yachts were!
Disclosure: This post is intended solely for educational purposes. Individuals should do their own analysis and/or consult with an advisor before investing.