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Individual Investors Should Treat Obtaining Financial Advice Like Buying a New Car

29 Tuesday Oct 2019

Posted by wmosconi in asset allocation, behavioral finance, Consumer Finance, financial advice, financial advisor fees, financial advisory fees, financial goals, financial markets, financial planning, financial planning books, financial services industry, Income Taxes, Individual Investing, individual investors, investing, investing advice, investing information, investing tips, investment advice, investment advisory fees, investments, personal finance, reasonable fees, reasonable fees for financial advisor, reasonable fees for investment advice, reasonable financial advisor fees, risk tolerance, stock market, Stock Market Returns, stock prices

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I had a long conversation with a friend and business associate about how I think individual investors approach obtaining financial advice.  We went back and forth for almost 30 minutes.  However, I found myself stumbling upon the analogy of purchasing a new vehicle.  This analogy encapsulates how individual investors might want to think about building their investment portfolios, setting financial goals and how to obtain them, establishing their risk tolerance, and addressing any special situations that might pertain to their specific situation (e.g. caring for an elderly parent in their house).  I should state at the outset that, if you have more than $1 million in investable assets (i.e. an accredited investor), the size of your portfolio demands special attention.  If you have not amassed $1 million, please read on to the rest of this article.

First, I would like to lay out the typical new vehicle purchase scenario and then turn to its applicability in the case of financial advice.  Most people start off the process by doing a good deal of research on the available options.  After considering his/her situation, the individual will go to the vehicle dealership.  For the purposes of this particular example, let’s suppose that the vehicle dealership offers a number of different car manufacturers as options and then the various models associated with them.  Luckily today, there is a lot less haggling (well at least upfront in the process) and the vehicles’ prices are normally right around the MSRP.  However, you as a consumer need to select the car make and also the specific model.

Usually a salesperson will assist you with the process.  Even though you can do a lot of homework prior to picking out a new vehicle, it still does not fully capture actually looking at the vehicle.  Of course, you also need to sit in it and take a test drive.  The salesperson is able to translate what your needs are to try to select the best option.  For example, do you need to transport the kids to basketball practice?  What if you take turns carpooling and pick up an extra 3-6 kids?  How big should your SUV be?  What if you drive a lot of highway miles and a lease option may not work for you?  Do you like to have a decent amount of horsepower to be able to merge onto highway traffic?  What about the manufacturer’s warranty?  Does the dealership service the vehicles onsite?  What about financing options (i.e. buy or lease)?  The list of questions could go on and on.

Given the entire list of questions you might ask, the salesperson is an integral part of the vehicle buying, or leasing, process.  After the salesperson has finally answered all of your questions, let’s say you decide on a price, the financing options, and the color/options/model.  If you make the purchase, the salesperson will earn a commission.  Once you leave the dealership’s parking lot, you are then responsible for the maintenance of the vehicle.  Fingers crossed, you should only need to take car of oil changes and normal maintenance (e.g. changing the air filter, flushing the transmission fluid, etc.).  What would you do if the salesperson came over to your house and wanted to check if you were still pleased with the vehicle you selected in the second year?  Does it fit your needs and perform as expected?  Wow, that experience would be one of pretty good customer services.  But now, the salesperson’s next utterance is that you own him/her $500.  What?  Well, he/she responds that he/she helped you out and things are going according to plan.  My guess is that you would be dumbfounded and refuse to pay another commission to the salesperson in year two of ownership.

What in the world does this have to do with financial advice?  I would argue that the analogy fits quite well with the normal way financial advice is given to individual investors.  When you first sit down with a Financial Planner, Financial Advisor, or Registered Investment Advisor, he or she really walks through your entire life situation.  Additionally, that person will assess your tolerance for risk which is not always as easy as it sounds.  Usually most financial professionals will include questions that relate to your behavior under certain instances of financial market conditions.  So, you cannot simply ask only objective yes/no questions.  Other big thing that may come up are any insurance, tax planning, or estate planning needs that you have.  Another significant area is trying to find out if you might have any special circumstances.  The caring of an elderly parent was provided above.  But there are myriad other situations that might require special planning considerations unique to your family.

The vast majority of financial professionals no longer charge commissions.  Rather, they will charge a fee based upon the total asset in your portfolio of stocks, bonds, other assets, and cash.  The financial services industry calls this an AUM (assets under management) fee in the jargon, and a very typical fee that one will see is 1%.  What does that mean?  Well, to use round numbers, let’s say you have $1 million dollars in your account of financial assets.  You would then pay a fee of $10,000 ($1 million * 1%).  To be technical though, the fee is normally prorated over four quarters throughout the year and not in one lump sum.  Given all the assistance that I listed in the previous paragraph, there is no doubt that the financial professional earns his or his AUM fee.  But what happens when year two of your financial relationship begins?

For illustrative purposes, I am going to assume that your life situation does not change at all.  In the first year of your relationship with the financial professional, he or she is likely to have prepared an asset allocation for at least the next five years.  One would expect a long-term investing plan.  Of course, he or she may recommend that based, upon the price movement in the financial markets, you should reallocate your investments to either the same target allocation in year one or slightly different percentages.  He or she may even recommend that you sell a particular investment and replace it with what he or she deems to be a better performing investment vehicle for the future.  Well, to keep using round numbers, if your investment portfolio stays constant, you would pay another $10,000 (again $1 million * 1%).

The year two situation is akin to car maintenance in year two of your ownership of that vehicle from my car vehicle purchase analogy.  Now, if you blew a head gasket in your car’s engine, you would want to take the vehicle back to the dealership or go to a trusted mechanic.  The latter represents a major change in your life situation, financial goals, income tax ramifications, and other major events.  Otherwise, we have a situation where you are paying the car salesperson another commission in year two.  Now my analogy may not be entirely “apples to apples” (as my business associate said during our discussion).  However, it is close enough to get to the point that I am trying to make in terms of financial advice.  You need to be very cautious with how much money you pay in expenses for financial advice.  Why?  It really eats into the investment performance returns you will realize.  I am all for paying for financial advice when there is a complicated situation, but, if nothing of import changes, it can be hard to justify.

So, what can you do if my analogy resonates with you?  Well, there are two options that I will provide.  However, there are other avenues to proceed down.  I will discuss each in turn.

First, you can select a financial professional that charges a fee-only amount or one that charges by the hour.  The fee-only financial professional will charge you a set amount per year for financial advice, and, in almost all cases, it is significantly lower than the $10,000 in our example.  The hourly financial professional is just as it sounds.  In the second year, you might require 10 hours of financial advice throughout the year, some of which might include just coaching you through the inevitable volatility in financial markets.  Depending on the area that you reside in, you can expect to pay anywhere between $250 to $500 per hour.  Using the 10-hour amount, you would be paying anywhere from $2,500 ($250 * 10 hours) and $5,000 ($500 * 10 hours).  Using either type of financial professional with a different fee structure will lower your overall investment fees.  Note that the quality of financial advice usually does not decrease in most cases.  And yes, there are certain cases where the quality will increase markedly.

Second, you can use an external investment account at the beginning of your relationship with a financial professional that charges a percentage of assets under management (AUM).  What does this mean?  The vast majority of asset managers are large and sophisticated enough to handle this arrangement at the outset.  For example, you would establish an investment account where your financial professional is located.  Next, you would establish an investment account with another brokerage firm and allow your financial professional to have access to the investment portfolio you maintain.  Note that the access is only for purposes of preparing reports for you and not to execute actual trades of stocks, bonds, mutual funds, or any other financial asset.  For instance, you might keep 50% with the financial professional’s firm and another 50% in the external account.  You would just maintain the portfolio allocation that your financial professional would like you to have in the external account.  In order to ensure that you do not deviate from his or her investment recommendations, your monthly or quarterly investment performance reports would lump together the assets at the financial professional’s firm and your external account.

In regard to the second option, just because asset managers can easily do this reporting for you, does not mean that they will not push back.  Some asset managers and financial professionals get even confrontational.  It is understandable since the more assets you maintain at their firm the larger the investment advice fee.  But this response can be very informative for you.  If your financial professional does not handle your request of this potential option diplomatically, this may be a cue to seek financial advice elsewhere.

So, have I successfully convinced you that buying investment advice is just like buying or leasing a new vehicle?  My guess would be that you think the analogy is not a perfect one.  I will readily admit that it is not and really is not meant to be.  Rather, I wanted to get you thinking about the financial advice you receive and investment fees from another viewpoint.  Investment fees have an outsized effect on the returns that you will experience over time.

Their impact is even greater if you take into account the “opportunity cost” of investment fees.  However, that is another topic entirely that I will not delve into.  If you would like more information on the idea of “opportunity cost” and investment fees, you can refer to a previous article that I wrote.  Here is the link:

https://latticeworkwealth.com/2014/02/26/what-is-the-800-pound-gorilla-in-the-room-for-retirees-it-is-12-5/

Now that Commissions on Stock Trades Are Zero, Should You Start Trading Stocks?

16 Wednesday Oct 2019

Posted by wmosconi in active investing, after tax returns, benchmarks, blended benchmark, finance, financial advice, financial markets, gross returns, historical returns, Income Taxes, Individual Investing, individual investors, investing, investing advice, investing tips, investment advice, investments, passive investing, portfolio, risks of stocks, S&P 500, S&P 500 historical returns, S&P 500 Index, speculation, stock market, Stock Market Valuation, stock prices, stocks

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Quite recently, Charles Schwab (an e-broker) announced that they would no longer be charging commissions on stock trades.  Shortly thereafter, TD Ameritrade, E*TRADE, Interactive Brokers, and Fidelity Investments all followed suit.  A financial technology (fintech) firm, Robinhood already offered commission-free trading.  So essentially, anywhere you open up a brokerage account to trade stocks, you will not have to pay any commissions.  The question is…….should you start trading stocks?

The aforementioned question is difficult to answer in relation to all the types of people that are reading this article.  However, whether or not you decide to trade stocks, I simply want to ensure that you are using the proper benchmark to gauge your success in terms of the performance returns you achieve.  Now I am assuming that, since you are trading stocks, the assets are held in a taxable brokerage account.  Furthermore, an active trader is likely to have a holding period for those stocks that is less than 365 days.  Therefore, the gains are fully taxable as ordinary income.  With that groundwork laid, let’s move on to a further analysis.

Trading stocks and “beating the stock market” is an extraordinarily difficult task to do.  Most of the professional asset managers fail to beat their respective benchmarks for performance returns.  Additionally, trading stocks in the short term requires two things:  gauging market sentiment correctly and the valuation of the stock based upon its fundamentals.  You have to be right on both accounts.  There are many times when a company has a ton of good announcements that should cause the stock price to increase, but other factors hinder the upward movement in the stock price.  Examples include:  negative sentiment about the stock market in general, negative sentiment about the industry the company is in, geopolitical uncertainty, poor economic data, central bank (Federal Reserve) policy, and many others.  The bottom line is that you can be exactly correct on positive news for the stock you are buying, but, if there are negative overhangs in the stock market for any reason, the stock price may not go up.

Another word of caution is just to identify what it means to trade stocks in the short term.  Trading stocks in the short term is speculation, plain and simple.  Short-term trading is not investing at all.  There are myriad reasons why, but I will not address that in this article.  Just know that you are a trader who is speculating on stocks and market sentiment related to the stocks you choose to trade.  Any holding period of a stock less than one year does not meet the bar of what investing means.  As long as you know that going in, that is fine and I will not dissuade you in any way from trading.

The important thing to remember is that you need to gauge your performance in relation to the overall stock market based upon after-tax returns and not gross returns.  Why?  At the end of the day, you only care about the terminal value of the asset in your brokerage account.  What do I mean by terminal value?  Terminal value just means the amount of money you have after paying capital gains taxes as ordinary income.  For example, if you have a 10% return in your stocks and the S&P 500 Index is only up 8%, you need to look at your taxes too.  Just for illustrative purposes, let’s assume that your marginal rate for federal and state taxes is 25%.  If we go back to the 10% amount, you will have a 7.5% (10% – 10% * 25%) after-tax gain from trading.  Yes, you beat the stock market return on a gross basis, but you end up with 0.5% less after all is said and done.

I am going to use the historical returns of the S&P 500 Index from 1957 to 2018 as the benchmark that you should be referencing when examining your success (or failure) as a result of trading.  As I have mentioned in many prior articles, I use 1957 as the starting year because the S&P 500 Index was created in that year.  Prior to 1957, the S&P Index had less constituents so going back in history further than that year does not yield an apples-to-apples comparison.  The long-term historical return of the S&P 500 Index over that period was approximately 9.8%.  Therefore, I will use that historical return to reference the gross return versus after-tax return issues.

Here is a table to look at the performance return you need to equal just to be even with the S&P 500 Index after taxes:

Gross Returns Versus Tax Equivalent Returns

As you can see, the gross return equivalents in relation to the historical return of the S&P 500 Index range from 12.3% to 16.3% for the various marginal tax rates shown.  For instance, if you are in the 30% marginal tax bracket for federal and state income tax purposes, you will need to earn 14.0% returns just to break even.  Most people add or remove monies to their brokerage accounts over the course of any given year, so you need to adjust for those cash flows.  The computations are a little trickier and beyond the scope of this discussion.

Another important thing to take into account is the types of stocks you purchase.  The stocks included in the S&P 500 Index are very large companies by market capitalization (large caps).  Market capitalization is simply the number of shares outstanding times the stock price.  If you invest in very small stocks that you deem to be good trading opportunities, you should not be using the S&P 500 Index table above to do your calculations for after-tax returns.  For example, if you tend to invest in smaller companies, you would want to use the Russell 2000 Index or the S&P 600 Index.  For any companies below $1 billion in market capitalization, you should seek out what are called microcap indexes.  The best way to build your personal table is to use a “blended benchmark” for performance returns.  A “blended benchmark” is what large institutions and high net worth individuals use, and it is the gold standard because you are truly comparing apples-to-apples.

If you want to learn more about how to create your personal “blended benchmark”, I addressed that topic five years or so ago and here is the link to that article:

https://latticeworkwealth.com/2013/07/19/how-to-create-an-investment-portfolio-and-properly-measure-your-performance-part-2-of-2/

In summary, if you decide to trade individual stocks because commissions are zero now or you have always done so in the past, you need to compare your after-tax return to what you would have earned if you had simply bought the S&P 500 Index via an index mutual fund or an Exchange Traded Fund (ETF).  Why?  Those performance returns would be available to you if you simply invested in one.  Note that the fees on index mutual funds and ETFs are extremely low (0.05% or less and in some cases like Fidelity Investments are free).  You always want to select your next best alternative to measure whether or not you are earning more than the stock market on an after-tax basis.  Remember that all you really care about at the end of the day is how much money you have leftover in your brokerage account minus what you pay in federal and state income taxes.

The Two Numbers the Financial Services Industry Does NOT Want You to Know Available on Amazon.com

11 Monday Nov 2013

Posted by wmosconi in asset allocation, bonds, business, Charity, Consumer Finance, Education, Fed Taper, Federal Income Taxes, Federal Reserve, finance, financial planning, Income Taxes, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, personal finance, portfolio, risk, State Income Taxes, stocks

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I wanted to pass along the latest installment of my book series, A New Paradigm for Investing that I have published on Amazon.com.  The subtitle is The Two Numbers the Financial Services Industry Does NOT Want You to Know.  Have you ever struggled with trying to determine how much value you get for the investment advice you are paying for?  It can seem like everyone has the same “pitch” and the same fees.  Since you are entrusting a Financial Advisor or other financial professional with a large part of your net worth and financial future, you deserve to know exactly how fees work in general.  I am by no means advocating dumping the individual you have developed a relationship with.  Rather, I would like to provide some insight into investment fees and how much they actually are when compared to your annual income.  I assure you that, if you are utilizing a full service brokerage firm or other advisory services, these figures will astound you.

Note that this book is available for download onto a Kindle.  Additionally, there is a Kindle app for iPhones and Android devices which is free to download.  Amazon.com prime members can borrow the book for FREE. I have provided a link below to make it easier.   My email address is latticeworkwealth@gmail.com should you have any questions/comments/feedback.

The link to the book is:

A New Paradigm for Investing:  The Two Numbers the Financial Services Industry Does NOT Want You to Know:

 

http://www.amazon.com/New-Paradigm-Investing-Financial-Services-ebook/dp/B00GCQACF4/ref=sr_1_1?s=books&ie=UTF8&qid=1384183129&sr=1-1&keywords=a+new+paradigm+for+investing+by+william+nelson

I would like to thank my international viewers as well.  I also wanted to especially thank some selected followers of my @NelsonThought and @LatticeworkWlth Twitter accounts (each of whom I would recommend following for the content and insight):

Followers on @NelsonThought:

The Wall Street Journal Wealth Report @wsjexperts – #wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Pedro da Costa @pdacosta – Reporter for Reuters covering economics and the Federal Reserve

Muriel Siebert & Co. @SiebertCo

Roger Wohlner, CFP® @rwohlner

Ed Moldaver @emoldaver

Sylvia Maxfield @sylviamaxfield

The Shut Up Show @theshutupshow

Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells – Editor of the Wall Street Journal Wealth Experts

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

Are Your Investment Fees Higher Than Your Taxes? Probably.

22 Tuesday Oct 2013

Posted by wmosconi in business, Charity, Consumer Finance, Education, Fed Taper, Federal Income Taxes, finance, financial planning, Income Taxes, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, NailedIt, personal finance, portfolio, risk, State Income Taxes, statistics, stocks, Uncategorized

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There are two important ratios that most individuals do not pay enough attention to.  In fact, the financial services industry rarely, if ever, makes mention of them.  They are as follows:

–          The first ratio measures the amount of your investment fees paid versus the total federal, state, and local income taxes you pay.

–          The second ratio measures the amount of investment fees paid versus your total income.

Why are these two ratios so important?  First, they bring to your attention the absolute dollar amount of investment fees paid to your Financial Advisor, your brokerage firm, and other third parties.  Second, you will note that, although you cannot choose to ignore paying your income taxes, you can lower the total amount you spend on financial and investment advice.  Lastly, you can think about what other uses you might have for the money you spend currently on investment fees either in whole or in part.  Let’s talk briefly about how to calculate these ratios and then delve into their usage in more detail.

The ratios are fairly easy to calculate.  The first ratio is investment fees paid versus total federal, state, and local income taxes you pay.  Luckily, most people do not pay local income taxes, and several states have no income tax.  If you do have one or both of these taxes, you simply add the total taxes due together from all three sources.  Note there is a big difference between taxes paid and taxes due.  If you received a federal and/or state tax refund, you still paid taxes into the system.  A refund is simply an adjustment to ensure that you only pay your fair share according to the tax code.  You would add up the taxes due to federal, state, and local agencies on your income tax returns.  Your investment fees come directly from your brokerage statement(s).  The two most common expenses are asset under management (AUM) fees and commissions.  You would add up all the AUM fees and commissions charged to your over the course of the year.  The only other number you need is to take your Adjusted Gross Income (AGI) from your federal tax return.

As I have stated in previous posts, the most common AUM fee is 1%.  So let’s take a common scenario for retirees today.  For illustrative purposes, assume there is a retiree with a $1 million portfolio in a 401(k) account that withdraws $50,000 and is charged a 1% AUM fee.  The total AUM fee would be $10,000 for the year.  If the retiree also has Social Security income of $20,000, the second ratio would be 14.3% ($10,000 / ($50,000 + $20,000)).  What does that percentage mean?  The percentage shows you that your investment fees are equivalent to 14.3% of your annual income.  Now the total taxes paid by each individual will vary greatly.  However, the average taxpayer tends to pay around 10%-15% in federal and state income taxes.  In our assumed scenario above, the total income taxes due would be $7,000-$10,500.  The first ratio is either 142.9% ($10,000 / $7,000) or 95.2% ($10,000 / $10,500).  What does that percentage mean?  The percentage shows that in the higher tax situation you are paying essentially the same amount in income taxes as you are in investment fees.  The lower tax situation shows that your investment fees are 42.9% higher than your income taxes.  No matter which way you slice it, you are in a high “investment fee” bracket.  The investment fees you are paying are yet another drag on the net income you end up having for living expenses and for leisure activities.  To a great extent, your income taxes are fixed in any given year unless you have an unusual income stream occur.  Your investment fees are variable every single year.

Now I am not saying that you should no longer use a Financial Advisor or go to your investment firm.  Please do not mistake that as my message.  However, I am recommending that you calculate those two ratios to bring the investment fees to your attention.  You can then make the choice regarding whether or not you might want to seek out a fee-only or hourly Investment Advisor or Financial Planner.  Or you might want to investigate if you have the knowledge or can acquire the knowledge how to manage your own investments.  What would be the incentive of those two alternatives?  Obviously I am biased, but nothing like these stories inspire me more.  My parents are in the grouping that would be charged roughly $10,000 per year in investment fees.  They are lucky enough to not require a Financial Advisor to whom they would pay a 1% AUM fee or similar level.  I recently found out that they will be taking a two-week cruise in Europe next month for essentially that same amount.  My father is fine with the vacation because he knows my mother deserves a relaxing time after her recent (and successful) battle with breast cancer, and he has listened to my logic in terms of the “savings” that they have each year.  You might debate the term “savings”.  I simply use the term due to the fact that they are taking a cruise rather than paying a Financial Advisor and his/her firm.  It is the same choice that you have when it comes to how you would use your money, if you did not have to pay an AUM fee.

For many other people, the monies can be used to help family and charities while you are still alive.  For example, you could decide to pay $10,000 toward your grandchild’s college education or add money to your grandchildren’s’ 529 college savings plans.  Or, if you have 15 grandchildren, you might choose to buy all of them an iPad for the holidays.  Conversely, the charitable uses for the money are almost as endless as your imagination.  One particularly interesting idea with Thanksgiving coming around the corner is paying for dinners for disadvantaged families.  The average family spends roughly $50 for a Thanksgiving dinner each year.  That figure sounds quite low to me.  What if you gave 130 families $75 toward their Thanks giving dinner next year?  If you wanted to split the monies between your family and charity, you could buy 65 dinners instead.  Imagine being able to allow an entire square block of families be able to enjoy a great meal or how many more free Thanksgiving meals a homeless shelter could serve with $5,000.    The great thing about this new-found freedom is that you will avoid the $10,000 AUM fee the following year again.  You can choose to do the same thing the following year in whole or in part.  Why not choose to get to know two local families, sponsor them, and pay for their groceries for the entire year?

Note that there is nothing that says you cannot see a fee-only or hourly Investment Advisor or Financial Planner.  You might pay $250 per hour for four hours or a flat fee of $1,000 on an annual basis.  In that scenario, you would be saving $9,000 ($10,000 – $1,000).  Plus, there is another thing that retirees fail to realize most of the time.  There is no rule that says you have to keep all your money at one full service brokerage firm.  There are many individuals that maintain an account at a full service brokerage firm and have another account with most of their funds at a discount brokerage firm.  The full service brokerage firm will want you to transfer the funds over to them, but I worked for years preparing performance reports for high net worth clients.  Many of them had money at other firms, and we simply included that information as data points in a customized report that showed all their assets and returns of their portfolio.  If your firm balks at you moving monies from them and tells you they might drop your account, I would seriously consider why you are at that firm anyway.  You can ask your Financial Advisor what value he/she provides that necessitates your keeping all your assets there.  I would encourage you to show him/her your two ratios and use that to start the discussion.

There may be certain cases where it is difficult to find your investment fees.  If you are not paying any commissions or an AUM fee, I certainly assure you that your Financial Advisor is not managing your money for free and he/she a nice person.  You should ask what fees you are paying.  Did you pay a load to purchase a mutual fund?  What is the expense ratio of your mutual funds or variable annuities?  There is a multitude of ways to charge fees, and it is in the best interest of a financial services firm to not disclose each of them.  Now I will clarify here.  You will most certainly get a financial note that says you are charged x percent, but it is quite rare for that percent to be changed into an actual dollar amount for you to view.  For the aforementioned scenario above, the firm should say that your AUM fee is 1% which is equal to $10,000.  The latter figure is much more impactful.

What are good benchmarks for the ratios discussed above?  The first ratio measures your investment fees versus your total income taxes.  A ratio of 10%-15% is a great target.  The second ratio measures your investment fees versus your total income.  A target of 1%-3% is a great target.  If you are accustomed to dealing with a Financial Advisor, it is quite unlikely that your ratios will approach those levels.  However, as previously mentioned your investment fees are variable and can change.  Your Financial Advisor may make the argument that he/she is needed to ensure your income taxes are strategically planned.  Well, he/she should have been doing that all along, right?  Isn’t that one of the reasons why you are currently working with a Financial Advisor?  If you have a tax plan in place and are not expecting an unusual sum or source of income, the additional cost of having a Financial Advisor as a “tax expert” is usually not a good cost/benefit option.  Why?  Does it make sense to pay a Financial Advisor an extra $9,000 per year over a fee-only Investment Advisor to ensure you do not pay an extra $1,000 in income taxes?  The net cash flow for you is a decline of $8,000; remember you can always consult your tax accountant or financial planner for an hourly consultation whenever a tax situation comes up.  Furthermore, you can arrange to meet with either party for at least one hour per year to speak only about taxes.

Lastly, I strongly encourage each of you to open a checking account at a bank or credit union that you only use to pay investment fees and income taxes.  It is very easy to find a checking account that charges no monthly fee whatsoever, especially at a credit union in your area.  There may be cases where it is inadvisable to pay investment fee via a checking account.  Why?  Well, you would have to withdraw the money, pay federal and state income taxes, and then send the money to your financial services firm.  In that case, I would encourage you to pay your investment fee with a check from your home equity line of credit.  Most of the time, you will be paying 3-5% in interest on a home equity loan.  The tax-equivalent interest rate at today’s levels is approximately 1.95-3.75%.  In order to highlight the level of investment fees paid, it is well worth paying an additional $200 or so in interest on your home equity loan.

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