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Living On a Prayer – The 1% Advisors

It’s been thirty (30) years since Bon Jovi released “Living on a Prayer.”  Crap!  I remember that song being played in high school at dances.  I guess that means I am getting old(er).  Some of the song’s classic lyrics were “Woah, we’re half way there. Woah, livin’ on a prayer.”  I’m not sure what the song meant as I was enjoying it too much while I had a comb in the back pocket of my pegged jeans.  The comb may or may not have been to keep my feathered doo in check.

Morningstar does a regular report analyzing the cost of fund fees and their updated report for 2015 made me think of this classic song.  The short version is costs for funds continues to decrease, however, it does not mean clients are paying less in advisory fees.  Something like that is definitely going to catch my attention and it should for you too.  Let’s dig into the data a bit and of course you will get my opinions.

Five years ago the average asset-weighted expense across all funds (this includes actively managed mutual funds and passively managed ETFs) was .73%.  In 2014 it was .64% and last year the average continued to drop to .61%.  A 12bps decrease may not seem a lot, however, it does result in keeping more of your money in your account.  Yeah, saving $1,200 annually on a $1 million portfolio isn’t that much, but it could pay your cell phone bill for half a year or make your car payment for a few months.  Plus, there is the beauty of keeping this $1,200 in your account and letting it continue to compound well into the future.

The term “asset-weighted expense” is important to consider because it gives a better representation of where investors are putting their money.  In 2015, the simple average expense ratio of all funds was a whopping 1.17%.  This number is skewed though as funds above this 1.17% held just 8% of assets in 2015.  In this analysis it is more salient to focus on the .61% figure.

Now, this drop in fees is not because fund companies are all responding to the marketplace and rolling out lower cost options for investors, but some like Vanguard are.  The majority of the decrease to this .61% average fee is the result of consumers becoming more aware of the destruction of what higher fees do to their portfolios.  They are smarter and are moving their investments to lower cost options.  From 2004 through 2014, roughly $1.9 trillion was invested in passively managed funds versus $1.13 trillion for actively managed funds.  Within this $1.13 trillion, $1.07 trillion went into those actively managed funds that were in the lowest quintile of expenses.  This means 98% of assets over the last decade have gone into the lowest cost options!!!  Holy Toledo!!!

In the last few years 401k plans had to disclose how much clients are paying for their investments and associated advisory fees.  The new Fiduciary rule will continue this theme by putting client’s interests first.  Clients are showing a proclivity toward lower-cost investment options and the companies who are positioned in this space are enjoying the rewards.  Where I see this going in the future is to the fees being charged by advisors.

Unfortunately, Morningstar did not do an analysis on the average fees charged by advisors.  I continue to see percentages charged by advisors ranging from .99% to 1.02% for assets under management (AUM).  Let’s just settle on 1%.  Regardless, I am seeing no data on fees being charged by advisors moving downward or even a trend toward advisors offering another option for clients to pay, such as my flat-fee model.  I do believe the trend of clients having access to more expense information will change this.

I won’t jump on my soapbox today.  If you read my weekly emails you know how I charge and my thoughts toward how I feel most clients pay based on a broken model.  This is mostly because there aren’t many other options out there.  Part of my job is to help clients think about the future.  When I look to the future of this industry I am 100% certain this 1% AUM model is a dinosaur and will soon be replaced by a fee model where clients pay based on the value they receive.  So, while investment fees are coming down remember you are half way there and the majority of old-school advisors are praying they are able to ride into retirement before their living shifts.

About Dan Johnson, CFP

I am the President and CCO of Forward Thinking Wealth Management, LLC, which is the flat-fee financial planning firm located in Akron, OH, and set up to work virtually with clients across the country. I charge clients a flat fee of $4,800 regardless of asset size. My firm is a solution to what I feel is a broken system where clients pay advisors based on something out of their control - the performance of the market.
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