Each year, Russell Investments does a nice job calculating the value of working with an investment adviser. They recently estimated the value added as a little more than 4% (which I'd argue understates the true value added).
This is the additional percentage return that investors can expect to receive by working with an adviser compared with going it alone, and includes the following services:
· Construction of a financial plan
· Basic investment advisory services
· Tax efficient investing consulting
· Help avoiding behavioral portfolio management mistakes
· Annual rebalancing
I believe that Russell Investments has left out a number of important elements that make working with a fiduciary adviser much more beneficial than working with a non-fiduciary adviser. Yes, there is a difference between an investment adviser acting as a fiduciary for advice given and a non-fiduciary investment adviser.
Here it is: Investment advisers are employed by registered investment advisers (my firm is an RIA) and are required by the Investment Advisers Act of 1940 to act as fiduciaries for the advice they share with their clients.
Investment advisers — typically employees of banks, brokerage firms and insurance companies — are considered salespeople by the act. They are not required to act as fiduciaries for the advice they share, since that advice should be incidental to the sales process. As a result, most do not act as fiduciaries for the investment advice they provide.
Why it's important that your adviser is a fiduciary
Non-fiduciary investment advisers are salespeople selling their firm's products and services and, as a result, tend to recommend investments that pay them more, regardless of whether they are the best options for their clients. Investment advisers acting as fiduciaries must always put their clients' interests ahead of their own. They are legally required to recommend the best options available for their clients, regardless of what they are paid.
As you might imagine, there is a significant difference between the quality of the investment advice that investors receive from fiduciary investment advisers and salespeople. Can the difference be quantified? I think so.
Estimating the added value of working with a fiduciary adviser
1. No soft dollars. One way advisers can get paid is by accepting soft-dollar, or 12b-1, payments from mutual fund families for recommending their funds. Most fiduciary advisers do not accept these soft-dollar payments. However, most non-fiduciary advisers do.
Eliminating soft-dollar or 12b-1 payments can reduce the expense ratio of a mutual fund by anywhere from 25 to 75 basis points. The additional returns achieved by using a fund with a lower expense ratio flow directly to the investor.
Add another 50 basis points for using share classes that do not have 12b-1 payments tied to them:
4% (Russell Investments' advisor value) + 0.50% = 4.50%
2. Lowest-cost share class. Investment advisers working for banks, brokerage firms and insurance companies are required to recommend their employers' investment funds first to their clients — regardless of whether these investments are the lowest-cost, best-performing options.
Investment advisers working in a fiduciary capacity cannot first recommend inferior funds to their clients. They must make the best recommendation possible for their clients. As a result, they generally recommend the lowest-cost share class of any investment. The difference in cost can be an additional 25 to 75 basis points.
Add another 50 basis points for using the lowest-cost share class possible for each recommendation:
4.50% +.50% = 5.00%
3. Lowest-cost broker/custodian/trustee. If you are working with an investment adviser from a brokerage firm, guess where your assets will be custodied and which firm will be doing the trading? If you work with a fiduciary investment adviser, he/she can evaluate and choose the lowest-cost broker/custodian/trustee available.
Think order execution at a brokerage firm isn't important? Take a look at this example.
Investors can save 25 to 50 basis points in trading costs and custody fees when working with a fiduciary investment adviser.
To be conservative, add another 25 basis points as a result of using more cost-efficient brokerage, custody and trust services when working with a fiduciary investment adviser:
5.00% + .25% = 5.25%
4. Competitive investment adviser fees. If you work with an investment advisor from a bank, brokerage firm or insurance company, I challenge you to accurately calculate what you are paying in investment advisory fees. Compensation to these advisors can flow from the firm that employs them as commissions, trails, base comp, bonuses, referrals and reimbursements. These advisers can also receive compensation from any one of 750 mutual fund families, a host of insurance companies and, of course, clients.
Fiduciary investment advisers typically only receive compensation from their clients. Nearly all the clients my firm has taken on that were using non-fiduciary investment advisers were paying at least 200% of market in investment advisory fees.
If you can't figure out how much you are paying your adviser because you don't see all the compensation received, chances are good that you are paying too much. Fiduciary investment advisers have to charge market-competitive rates. Their compensation is transparent.
Because non-fiduciary investment advisers have a compensation stream that is not transparent and because fiduciary advisers have to charge market rates, non-fiduciary advisory fees can be up to 250 basis points higher.
Again, to be conservative, add 125 basis points when working with a fiduciary adviser:
5.25% + 1.25% = 6.50%
Why?
I believe that investors working with non-fiduciary advisers can increase the return on their portfolios by at least 2.50% by converting to a fiduciary investment adviser. Compounded over the 30 or 40 years investors save to fund their retirements, that can be hundreds of thousands of additional dollars. In addition, working with an investment adviser acting as a fiduciary can eliminate all conflicts of interest, resulting in higher-quality investment advice.
Why would anyone ever purchase investment advice from an adviser who isn't a fiduciary?
