Is your financial advisor worth $600 per hour?
Larry MacDonald recently joined the growing chorus of writers who wonder why anyone would want to use an investment or financial advisor. Certainly, in some contexts, people do need professional financial advice and I have always believed even the most sophisticated and stubborn DIY investors require financial advice from time to time, paid on an hourly basis, to provide some detached opinion on whether their investing strategy is sound and is being executed properly.
Accordingly, the question should not be framed as whether you need a financial advisor but whether they bring value to a particular investor? For example, a financial advisor who provides a 2nd opinion for $250 to a DIY investor with a 20 year investing horizon could bring value if their opinion was sound and it held credence through most, if not all, of that investing time-line.
However, if we answer the value question in the form of an hourly rate (once a lawyer, always a lawyer…), the findings could shock you.
Nothing in life is free. Financial firms and their distribution network of advisors and planners are compensated through hidden (in the sense they are not upfront like a trading commission) fees known as management expense ratios (MER). MER is typically expressed as a percentage determined by a products’ operating expenses divided by the average dollar value of the product. All mutual funds and exchange traded funds charge MERs. The MER is deducted before calculation of the products’ return.
I am going to use Million Dollar Journey’s example of the erosion of investment return based on higher MER; in his post, MDJ compares the costs of a DIY, low MER portfolio versus an active mutual fund portfolio with a 2% MER per annum. I am going to assume the mutual fund portfolio involves the use of a financial advisor.
Using his assumptions (which he freely admits are overly optimistic as to rates of return), an investor investing in an active mutual fund portfolio is losing $12,016 in fees after 20 years compared to their DIY counterpart. In other words, the loss is $600.80 a year, or $600 to make the math simple. If we recategorize this $600 not as a MER but as the cost of professional advice, how much value are you getting?
Let’s assume you have a bad financial advisor who calls you in for an appointment once a year for an hour under the same old routine: exchange some small talk, update on your situation, review your portfolio, top up your retirement funds, highlight of what’s hot and cue the sale pitch. That’s $600 per hour for the advice you just received.
Let’s say you do an extended lunch meeting for 2 hours. That is a $300 per hour tab. If you have a good advisor who spends 3 hours, you are down to relatively palatable $200 per hour. Four hours a year results in your financial advice costing $150 per hour.
To put this context, here are average billable rates per hour for lawyers and accountants:
- Average American lawyer (source: Incisive Legal Intelligence as of July 2009): $284
- Average Canadian lawyer (source: Canadian Lawyer Magazine, June 2009): $231
- Average American accountant (source IMOA, 2008) : $225 (no Canadian info found in limited time searching)
You have to remember that lawyers and accountants set their billable rate in an analogous manners as a MER (the majority of which is advisor compensation). In essence, take your costs add in a desired profit margin, adjust for market conditions, and you have your billable rate/MER.
Setting aside performance, do you believe that approximately 2.5 hours of time with a financial advisor is worth 1 hour of your accountant’s time? It is, admittedly, an apples and oranges comparison.
But look at the value question both quantitatively and qualitatively. Time does not necessarily equal value but time spent is inverse to advisor indifference. Thus, is your advisor spending sufficient amounts of time with you to lower their “billable rate” to something reasonable?
More to the point, does their performance justify this billable rate? At least with accountants, you are minimizing taxes and with lawyers you minimize risk, facilitate the purchase of large assets, defend your civil liberties etc. For upwards of $600 per hour, does an adviors provide sufficient results which a DIY approach could not match or beat?
The question is contextual. Some great advisors are worth more than $600/hour but you never hear of them because they are so busy servicing their clients well. But, is your advisor worth their hourly rate?