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Are You Getting What You Paid For?

The title of this post is the first line of the November 2016 AAII Journal “Editor’s Note” written by Charles Rotblut, CFA. I previously established that having someone else do the investing is going to cost in terms of fees and probably performance. I believe paying fees is okay as long as one knows exactly what fees are being paid.

Rotblut writes:

     > Even a 1% [management] fee should raise
     > questions… If both the S&P 500 and the fund
     > achieve a 7% return, you lose 14%… your after-
     > fee gain is not 7%, but 6%, a 14% difference.

This is misleading. Calculating percentage of percentages is a great way to magnify numbers and make them seem more sensational. To recoup a 1% fee, my adviser needs to do 1% better than the benchmark—not 14%.

     > It’s not unusual to see companies pitch
     > newsletters and strategies promising market-
     > beating returns. Ask how they are calculated
     > and you will often find out that they are
     > based on backtesting or paper trades. Run
     > the strategy in an actual portfolio where
     > trading and transaction costs matter and
     > the returns may be significantly lower.

These are excellent points. I mentioned this here in addition to a lengthy discussion beginning here.

My latest realization is that most people are probably paying more than just advisory fees. The management fee is most common and this goes straight to the adviser. My experience suggests most advisers buy mutual funds or ETFs for their clients and as shown in prospectus examples, all of these funds charge operating fees at the very minimum. So whether I hire a human or robo-adviser, I will likely be paying fees to the fund companies in addition to the advisory management fee. These additional fees may remain hidden unless I study the prospectus or ask the adviser.

     > …if you are going to pay for active
     > management or professional advice, be
     > sure you are getting what you pay for.

This sounds good but how can it possibly be measured? For many people, I think customer satisfaction is as straightforward as beating the “benchmark” and/or seeing the investments grow.

Rotblut further explains:

     > Are you getting better returns, more income,
     > better education on how to invest or help
     > in staying disciplined over the long term?
     > [italics mine]

I covered the first two above. #3 is meaningless. “Better” education: better than what? I doubt I could even assess this. #4 is also meaningless because “help in staying disciplined over the long term” is only something that can be evaluated in retrospect. Bailing out in the midst of a market crash means I wasn’t disciplined if the market subsequently rebounds leaving me on the sidelines. Years of paying fees may pass before an event like this ever occurs.

When shopping for a financial adviser, I think it is important to identify the complete fee structure to allow for apples-to-apples comparison between different services. I’m skeptical as to whether I can determine if I am (will be) getting what I pay for. The meaningful decision is whether I want to bite the bullet and pay someone else for what I would otherwise have to do myself.