A close friend recently switched jobs and was referred to a financial advisor by another friend. The advisor is charging my friend 2.5% to manage his portfolio!!!!

I gasped when I heard that. I’m a money nerd, and it’s easy to forget that not everyone researches money the way I do. In my little bubble, I couldn’t see how anyone could charge a management fee that high in 2022.

My friend is a young baby boomer. I suspect that people in the boomer generation and my Gen X peers are more likely to overpay for a financial advisor than our younger counterparts.

We grew up in an age of little information about personal finance and investing. Most of us had very little financial education when we entered adulthood. We began investing through 401K’s in the 80s and 90s.

I wish my friend and I would have talked about money before he committed to his new financial advisor. Since he and I missed the opportunity, I decided to share two warning signs to look for in your relationship with a financial advisor.

Paying more than 1% for Assets Under Management (AUM)

The industry average pricing for financial advisors runs at about 1% of AUM. There are more affordable options available, but if you feel that you must have a financial advisor, steer clear of anyone charging more than 1%.

Better yet, find a fee-only financial advisor. These advisors charge hourly for advice, and the fees are not related to the size of your portfolio.

You may feel that a financial advisor provides an advantage since you know little about investing. The sad fact is that financial advisors rarely beat the market. According to Phil Town at Seeking Alpha:

Large-cap fund managers — people who could be considered the most elite of the elite when it comes to financial advisors — are outpaced by the S&P 500 a staggering 92.2% of the time.

Every penny you overpay to a financial advisor hits your bottom line in a big way.

If you place $100,000 in the care of a financial advisor and the market returns an average of 7% over ten years, your future balance would be $200,982.

compund interest
Image from Nerd Wallet Compound Interest Calculator

When you pay your advisor a 1% AUM fee, your balance after ten years drops to $181,952. On top of the fees you paid the advisor, you also lost $19,000 of gains.

And for the unfortunate soles paying 2.5% AUM, it’s much worse. That $100,000 only grows to $156,707 in ten years. You wind up giving up $44,000 of gains. And your advisor has little to no chance of outpacing the market with your investments.

Fiduciary Responsibility

Not all financial advisors have a fiduciary responsibility. A fiduciary, by law, must manage a client’s assets for the client’s benefit and not their own. If your financial advisor is not a fiduciary, they have no legal obligation to place your assets in investments that are beneficial to you.

Your advisor may recommend high fee products for which they earn commissions. Some examples of high fee products include whole life insurance, annuities, and some mutual funds. These fees are often hidden and further erode your returns.

A fiduciary may still recommend investments with relatively high expense ratios. Funds managed by people have costs, which get passed on to the investors. Sadly, these funds also rarely beat the market.

The Vanguard Total Stock Market Index Fund (VTSAX) paces the market and has an expense ratio of 0.04%. This fund is one of the lowest-cost investments available. Look at the expense ratios for the funds to determine the impact on your investments. These costs are not easy to spot, but you should be able to find the expense ratios documented in the investment product prospectus.

A fiduciary is obligated to place your assets in investments that benefit you, but they are not bound to find the lowest cost funds. Meanwhile, an advisor who is not a fiduciary has no legal obligation to look out for your best interest.


Self management

You probably don’t feel comfortable managing your own money if you have a financial advisor. Self-management can be a scary proposition, but it’s not as complicated as you think.

If you read The Simple Path to Wealth by J.L. Collins, he lays out the easiest way to manage a portfolio of investments with low-cost funds. Converting your assets in a tax-advantaged account is easy. Taxable investment accounts are tricky because you can trigger capital gains by converting your investments from high-cost funds.

Robo-advisor accounts

Many Robo Advisor options manage your investments, rebalance, and even perform tax-loss harvesting. These services have fees as low as 0.25% and are available from Betterment, Wealthfront, Vanguard, and many other wealth management companies. Most of these offerings also offer low-cost fund options for your assets.

These products provide more support than self-management at a lower cost than a human, financial advisor.

Fee-based financial advisor

If you feel that you need a human, your best bet is a fee-based financial advisor. Make sure the advisor is a fiduciary. The advisor is paid by the hour and not based on the size of your portfolio. The fiduciary is legally obligated to provide advice in your best interest.

Always look for the expense ratios of the recommended funds. These fees also impact your long-term returns.

Final Thoughts

You may not know much about managing investments. That’s OK. It turns out that even the best experts can’t consistently beat the market.

If you pay more than a 1% AUM fee to a financial advisor, you pay WAY TO MUCH.

Make sure you are working with a fiduciary. Your financial advisor needs to be legally obligated to make investment recommendations in your best interest.

Consider alternatives, including self-management, Robo Advisors, and fee-based financial advisors. Every penny you shed on fees related to your financial advisor and fund expenses impacts your returns. Look for low-cost advisory services with low-expense funds that track the market.

You worked hard to create your savings. Don’t throw away future gains on a bad relationship with a financial advisor.