Monday, August 28, 2006

Pondering the cost of professional invesment managers - fees for assets under management (AUM)

I have mentioned in previous posts that I was seriously considering hiring an investment advisor (as part of a long term strategy to hire a financial advisor in general).

The overall reasons were:

1. Nuetral third party advice and criticism
2. Provide the discipline to stickto a diversified investment plan and rebalance frequently
3. Help me avoid impassioned short term mistakes, such as single stock bets (like SNDA)

While reading William Bernsteins the Four Pillars and hearing from friends about the DFA funds and their incredibly broad inventory of inexpensive passive index funds I was even more motivated.

Virtually all of our retirement monies currently sit in Charles Schwab's 2040 retirement fund SWERX. While slightly beating the S&P 500 this year, it is still composed of actively managed funds. Over time, it's not likely to beat the relevant indexes. Furthermore, I'm paying expense ratios of about 1% (plus the invisible costs of market impact, transaction costs incurred by the fund, bid/ask spread, etc...). What I did like about SWERX is that it should automatically rebalance allocations based on my age - a big failure of mine has been avoidance of rebalancing. Also, it would automatically diversify our investments. However, their underlying funds are active and there is not enough transparency to incorporate their fund holdings into a single asset allocation strategy.

Using an adivsor would cost me anywhere from 0.25% to 0.6% to 1% of assets under management. However, as my investible assets under management are still under $500k, I would be hit by minimums cost $2000 to $4000 per year, which would push my advisory fees into the 0.5% to 1% range if I looked at those under 1%. Quite honestly, the numbers bother me. Inexpensive passibly management funds have low expense ratios, most domestic would be 0.35% or lower with international up to 0.7% depending upon the size of the asset class (small vs. big). Overall, the expenses would be very cost competitive with what I have right now, until the minimum fees are factored in. Assuming we save from $50k - $100k per year, we still would have about 3-4 years or minimum fees. Then again, maybe that isnt' a big issue in light of the fact that we'll keep our money under management for many more years (30 + depending upon mortality).

Here's my question for you: Does it make sense to bite the bullet for 2-3 years with higher expense ratios until our asset size causes the minimum fees to approach the standard percentage? Or should I try managing it myself, hoping that I'll rebalance, or do nothing, keeping the money in the life cycle funds?

Considerations for moving to an advisor right now:

1. We can afford the extra expense out of after tax savings and it won't impact our life styles
2. The improvements in investment products (lower expense rates, less actively managed)
3. Better asset allocation
4. Rebalancing performed reliably

Against going with the advisor right now:
1. We may pay as much as 0.4% extra than we are paying now for three to six years - about $1600 extra per year - a total of $4800 - $9600.
2. We may have to move accounts to different brokerage firms - lots of paperwork - in order to enjoy the custodial services needed by our advisor and have access to DFA type products.
3. Giving up my own active management / active hand in investements (maybe this should be in the pro list for advisors?)

I have a feeling a good advisor, better allocation strategy, regular rebalancing, access to professional advice and thought will probably be worth the $1600 we would spend each year.

What do you think?



mOOm said...

If you want to go down the diversified passive indexing approach I can't see any use for an investment adviser. If rebalancing periodically is a problem put a note in a diary or some system of reminding yourself - "rebalance this week" or whatever to remind yourself to do it. Or write the rebalancing date on the sidebar of this blog :) More general advice on taxation, retirement vehicles etc. is probably useful.

makingourway said...

I generally find the complexity of business, family and other matters careen's into the responsibility of rebalancing with enough impact to derail me from doing it regularly.
Oddly, I find it easeier to put money in regularly than move it around!
I also think the advisor will be a helpful sounding board for different ideas and a somewhat nuetral advisor aware of my tax, estate and other financial details.

I'll be using the advisor for personal financial planning, too.

An active trader such as yourself, would certainly find rebalancing an insufficient requirement for an advisor.


mOOm said...

By the way UBS are only going to charge us 0.25% and provide advice on investments. But to actively manage they would want 1%. We are moving my mother's account from Citibank (poor and deteriorating service). We are also placing some with an advisor in Israel who invests in the US witht he wrap account model.

makingourway said...

0.25% is a good deal from UBS. My only point of discomfort would be conflicts of interest with the rest of the organization (which may sell by commissions and/or profit from proprietary products).
I'd be careful with the WRAP model - as I understand it - the advisor trades for you using a fixed % of assets fee. Are there any additional transactional fees that would encourage him to churn your account? Also, will he be using an active or passive investment model. As you know, I'm becoming increasingly skeptical of active investing models - though I still have some confidence in active trading models - but I like to distinguish active trading as someone participating daily in the market as a professional vs. active investing where you are not an active market participant and cannot benefit from risk controls like stops, etc.... Even then I'm a bit cynical about it as well over the long term - even the nation's big pension funds are moving away from actively managed investments.