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Who Invented the 1% fee? Only “Oliver” asks "Please Sir I'd like some more!

Good afternoon - Successful inventors have always been the catalysts for tremendously impactful societal and economic changes over history. Thomas Edison is credited with inventing the light bulb, Alexander Graham Bell – the telephone, and Steve Jobs – well seemingly everything else (except the Internet which of course Al Gore created!) Clearly these inventions have an amazingly life changing impact on virtually everyone living in any developed country. An “invention” that is never discussed – but felt by most every investor working with an advisor today - is the “1% of Assets” advisory management fee. The unknown “creator” of this approach has funded an entire industry on the wallets of retail investors.

 

At some point over the past 20+ years, 1% of your assets became the accepted pricing “norm” in the financial services industry. Having worked in that environment for over 2 decades, I have seen this pricing model become as standard as the Ticonderoga #2 pencil was for taking SAT tests (btw - is there anything other # than a #2 pencil?) Many national brokerage firms regularly use a “Return on Assets under management” as one of many evaluation metrics for their advisors (i.e. $100,000,000 in client assets generating $1,000,000 in annual revenue for the firm = 1% Return on AUM) The higher the % the better.

I feel very strongly that from a consumer’s standpoint this pricing approach is biased and therefore broken for many reasons which I will discuss below.

Guaranteed Raises for the “Fee Only” Advisor

If the broad equity market rises 14% (as it has done this year) does an advisor deserve a 14% raise in their fees? I doubt many investors feel strongly positive about that scenario but this is exactly what they have agreed to when they work under a “% if asset under management” fee arrangement with their advisor. “Fee only” advisors (advisors who will only charge a client a management fee vs. commissions) claim they sit on “the same side of the table” as the client from a pricing standpoint – “we only do better if you do better”! Huh? Certainly, good client focused financial advice has a distinct value - but should the price of this advice increase as the asset level increases?

“Have more money? – we will lower the “%” charged!”

Often, “fee only” advisors will reduce the “pricing percentage” as a client’s asset level increases – when new funds are added to the relationship. Sounds reasonable – or does it? A million-dollar portfolio priced at 1% generates $10,000 in fees for the advisor. A two-million-dollar portfolio at .85% generates $17,000 in annual fees, representing a 70% increase in the revenue charged by the advisor. In most cases the new investment was added to the existing portfolio model. This additional “work” earned a 70% increase in fees earned! This approach reminds me of the scene in the musical Oliver, when Oliver Twist dares approach the housemaster during dinner - “Please sir I’d like some more”! Unlike in this scene where Oliver is the only boy to ask for “more”, when it comes to financial services fees, investors are unwittingly lining up to ask for “more advisory fees” every time they add money to an existing account! Again, good client focused financial advice has a distinct value - but should the price of this advice increase as the asset level increases?

Internal Investment Fees – the hidden return assassin!

What is rarely discussed with investors is the additional expenses incurred inside many portfolios filled with the excessive fees of mutual funds or unit investment trusts. It is common for the internal expenses of funds used in portfolio models to exceed .80%. Assuming an advisor is charging 1%, and the funds expenses are .8%, the true blended fee incurred by the investor is 1.8%. If an investor is seeking a 6-7% annualized return, the assumed blended 1.8% fee represents a staggering financial hurdle to overcome. Would anyone agree to pay a 30% fee? On a 6% annual return, 1.8% in fees is just that!

Summary

Piedmont Wealth Advisory was founded in March based on extremely client focused values. One such value is our very unique “FLAT FEE” pricing model. One of our goals is to ensure investors have the opportunity to work with experienced financial fiduciaries and pay an annual flat fee for this service, regardless of their asset level or where their assets are custodied. This approach truly puts us “on the same side of the table’ as our clients. A major differnece to understand - A "Fee Only" advisor's fees are a percentage of your assets and your "Fees only" go up when your asset base grows.

Thank you for your time and confidence.

Douglas Birnie

“Big Ten Dougie’s” weekly Penn State Football update: PSU heads up to Columbus for a Saturday afternoon clash with the Ohio State Buckeyes. The victor of this weekend’s game likely will be heading to the Big 10 Championship game – with that winner heading to the Football Playoffs. My heart is rooting for all the above to favor PSU – my travel budget should they make it to the Playoffs?....Not so much!