Investing can be intimidating, so it might seem like using a financial advisor or a wealth management firm like Edward Jones or Merrill Lynch is your only option. What these advisors probably won’t tell you is that the fees they charge will end up costing you a huge portion of your life savings (around 25-30%) and will essentially halve the amount of money you can live on in retirement.
Contains affiliate links. See my full disclaimer.
Sound crazy? Before I get into how those seemingly small fees add up to a gargantuan amount, let me explain the difference between index funds and actively managed funds:
- Index funds follow indexes like the S&P 500, total US stock market, or total international market. Actively managed funds have managers that pick which companies to add to the fund.
- Index funds have very low fees ranging from around 0.04% to 0.2%. In contrast, an actively managed fund usually charges around 1% and can sometimes come with a 5% load charge (extra money that is paid when you first buy the fund). This is on top of the assets under management fee (another 1%) that most advisors and wealth management firms charge.
- Despite being far more expensive to own, 90% of actively managed funds underperform inexpensive index funds.
- Many financial advisors make commissions from putting their clients in certain actively managed funds which could explain why these funds are so popular with advisors.
So how much does using a financial advisor who puts you in actively managed funds cost you?
If you saved $10k/year, you would have $1,026,589 after 30 years, assuming an average annual return of 7% (slightly under the long term average S&P 500 return. This figure includes stock market crashes). This is BEFORE FEES. If you know nothing about investing, you’ll probably go to an advisor who will charge you a 1% management fee on top of a 1% expense ratio for the actively managed funds they will likely invest your money in. That 2% doesn’t sound like a lot, but it compounds into something huge. After 30 years, you will have paid $280,219 in fees leaving you with $746,370 of retirement savings out of the $1 million you would have had before their “small” fees. That’s more than 27% of your life savings.
How much in fees you’ve paid out of your $1 million life’s savings
These financial managers might not tell you that their expensive actively managed funds actually underperform low cost passively managed index funds (which have an expense ratio of around 0.04%).
If you had instead invested in index funds from a firm with no commissions or management fees like M1 Finance, you would have paid $6,770 in fees over 30 years, leaving you with a $1,019,819 nest egg at end of your three decades of saving. I’m not even factoring in the fact that the expensive actively managed funds your advisor puts you in usually have lower returns in the long run than simple index funds. Think about how many extra years you’ve had to work to pay your advisor over 27% of your life’s savings.
It gets even worse in retirement. Retirement experts say you can safely withdraw 4% of your nest egg in retirement without running out of money. If you are paying 2% of your portfolio to an advisor in fees each year, that only leaves 2% for you to live on. So if you had $1 million invested index funds, you could withdraw $40k/year to live on. If you are paying an advisor to “manage” your $1 million in actively managed funds, you have the privilege of handing $20k each year to your advisor, leaving you with only $20k to live on. Sounds like a way less comfortable retirement, right?
A few more things to keep in mind about actively managed funds vs index funds
“I like that someone’s watching my money.”
This is exactly why actively managed funds and portfolios underperform the index. Studies have shown that the more you tinker with your portfolio, the less money you make. In fact, in a study of the highest portfolio returns, dead people and people who forgot they had an account had way higher returns than anyone else! Investing is WAY less scary and complicated than in seems. Drop your money in an index fund that tracks the stock market and forget about it until you need to draw the money out in retirement. If you are older or more risk averse, put a percentage of your portfolio into a fund that tracks the total bond market. Then once a year, rebalance your portfolio by shifting money from your stock fund to your bond fund or vice versa to get back to the original allocation you set (30% bond/70% stock is one example). OR use a commission free brokerage firm like M1 Finance that automatically rebalances your portfolio for you.
“But the actively managed fund my advisor put me has beat the index/S&P 500 over the past 5 years!”
A few things. Only a tiny fraction of active managers outperform the index in the long term time frame (20-40+ years) people should be investing in. There is a reason Warren Buffet is so famous. Because he’s such a rarity. Even he realizes this and has instructed that all his money be put into in index funds to take care of his family after his death.
Also, there is a reason why current actively managed funds look like they have decent returns. If an actively managed fund underperforms several years in a row, the managers will often close down the fund and take everyone out of it rather than have the poor performance on the record. So the funds your advisor is showing you are generally only the ones who have maintained a few years of good returns compared to the index; the rest have been scrubbed from the books. If and when these current good funds underperform, they might also be closed down and whatever is left of the clients’ money will be moved to a different fund, sometimes a brand new fund created to start over and erase the poor stats of the last one.
“Why would an advisor recommend something that isn’t in my best interest?”
Unless they are fee based or a fiduciary, most advisors make commissions on actively managed funds and are therefore more likely to recommend them.
“My money’s in an IRA with my advisor. Is it stuck there?”
No. You don’t want them cutting you a check either, because if you don’t deposit it within a certain amount of time you will have to pay taxes on the money PLUS a 10% early withdraw penalty if you are under age 59 1/2. The easiest thing to do is create an account with your new brokerage firm (I like to recommend M1 Finance because they are free and completely automated) and ask them to initiate a transfer from your old firm. They do the work, and it’s quick and painless.
This content is for your information purposes only. I am not a financial professional, this is not professional investment advice or recommendations, and the information on this blog is based on my own experience and opinions. Always do your own research and analysis or consult a financial fiduciary before making any financial or investment decisions.
Pin for later: