It’s pretty well known by most people that Albert Einstein was a pretty sharp guy. Without getting into a summary of his Theory of Relativity (which I would get wrong anyway), one of his more famous and wise statements was:
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
While he was specifically referring to interest payments or interest income, the theory applies to growth of just about anything in percentage terms. In short, it’s the “growth on the growth” year after year that is mathematically astounding over a longer period of time.
Most people think of this concept in terms of wealth accumulation and that certainly applies. But what often gets overlooked is that this concept cuts both ways and it can cost people millions (and I mean millions) of dollars over 20 or 30 years.
How? Excessive fees paid for financial advice and investment management.
I know, I know – there are some of you out there that might be saying “but I’m not paying anything!” or “the insurance company pays my advisor” but we should all know there’s no free lunch! You are paying whether you see the fees explicitly listed on your statement or not. Next time those investment statements come in, take a look at your mutual funds and do a Google search on the expense ratio of the ticker of the fund. It should take you about 10 seconds to get a good estimate of the fund fees. Then, if you are working with an advisor, ask them how much their AUM (asset under management) fee is, in addition to the mutual fund fees they recommended.
Some might be saying: “So what? I’m paying for performance.” But the dirty little secret there is that almost all actively managed (i.e. expensive) funds actually under-perform their much less expensive index-fund peers! For more detail and empirical evidence on this check out my blog More Than Luck.
The issue is not that financial advice is very, very valuable (yes, I’m biased in that regard), it certainly is. But true value can only be judged when you know the accompanying price. If you don’t know the price, you cannot judge the value!
This is why our firm tells all clients and prospects up front exactly how much they are paying in fees. The first reason is that we remain completely objective in that no one pays us except our clients. We accept no commissions, referral fees or even the occasional branded coffee mug. The second reason, is that we’ve found our fees (while not cheap) plus low expense ratios on passive funds actually saves our clients substantial sums of money. This is over and above the conflict-free advice we provide on just about everything financial.
Think that’s hyperbole? Check out the chart below. The chart compares the growth of a $1,000,000 portfolio, starting in 2016 and going out 20 years and 30 years. The average growth rate of the portfolio before fees is 8% per year, compounded which is the average of a 50% equity / 50% bond portfolio from 1926 to 2015.
We have in our chart 3 scenarios:
- Portfolio growth with a 1.5% per year in total fees (which is a good approximation of asset management and fund fees) after 20 and 30 years
- Portfolio growth with a 2.0% per year in total fees after 20 and 30 years
- Portfolio growth with an example fee of $7,500 average annual retainer fee plus 0.20% fee on the portfolio (for passive fund expenses) (PLEASE NOTE: This is an estimate, our annual fee can range higher or lower than $7,500)
As you can see, the difference is astounding. In short- if a 55 year old couple started with $1,000,000 and lived 30 years, they could SAVE between $2 million – $3 million by the time they reach 85 by NOT paying the 1.5% or 2.0% annual fees.
Of course, the cynics might say we are “talking our book” and trumpeting our own model. We won’t deny that, but the math is indisputable. The point is, even if you never hire us for advice, we strongly urge you to seek out a financial planner who uses a retainer based model. Not only will you usually get objective advice on all aspects of your financial life, your portfolio will most likely grow to a point where it dwarfs a similar portfolio using a high-fee model!
Remember – the second part of Einstein’s statement is the most important- “…..He who understands it, earns it … he who doesn’t … pays it.” Now you understand – don’t be the one that “pays it”.