Could You Be Paying 4.7% On Your Professional Financial Advice?

Do you use or have you been thinking about using a financial planner to manage your investments?

We don’t, and I personally haven’t been very intrigued about hiring one. I’m sure there are some great ones out there, but I’m not sure how I’d find a great one, how I’d know it if I had, and if we’d have a portfolio sufficiently interesting (that is—sufficiently mammoth) to be able to hire him or her (or maintain enough of his or her attention).

I also feel like we ought to be able to figure out enough to manage the amount of investable money that we do have. Reading personal finance books, magazines, and blogs has so far reinforced that thinking for me: personal finance is not rocket science. Which is a good thing if it’s true, since I have a pea brain that would not cause anyone to mistake me for a rocket scientist.

There are also lots of folks who think that, if many professional money managers running mutual funds can’t beat the market, there’s not a whole lot of use in trying to hire a financial planner to try to beat the market.

While I’m piling on, I also believe that there are lots of bad financial advisors out there, who aren’t really all that good with their own money (let alone yours) or who have fee structures that motivate them to push certain products that may not be in your best interest. Lots of them have given me the feel of a sleazy salesperson, circling like vultures, calling just a few too many times and just a bit too often to try to get a lunch meeting, and otherwise not taking not-too-subtle hints that I'm not all that interested.

And how much you are really paying for financial advice—and what kind of gains you are truly realizing—may be hard to figure out if you don't really dig deep. Money magazine ran an article titled, “How Much You Really Pay for Advice” in its July 2008 issue—that I think is quite worth checking out. It’s a column from an anonymous writer known only as “The Mole,” described as “a certified financial planner and certified public accountant who—in the interest of fairness—thinks you should know what goes on behind the scenes in financial planning.”

I know—very sexy, intriguing, and well, almost tabloid-style, as personal-finance magazines go.

Anyway, The Mole helped a client decipher the true cost of investments that he had made through a financial advisor:

For one recent client, I had the sad task of estimating that he was paying 4.7% a year for an annuity, broken down as follows: 1.6% to his adviser, 1.6% on his funds and 1.5% in insurance costs that provided virtually no benefit.

Why is it so important to know your total costs? Because they eat into your return. If stocks beat inflation by five percentage points and bonds by one point, then an equally weighted portfolio will earn about 3% annually after inflation. If you give up 2% in costs, you’ve surrounded two-third of your real return. Taxes will grab the rest.

So in The Mole’s illustration of returns, at 2% in total costs, you are just breaking even. So the person paying total costs of 4.7% on the investments recommended by his advisor is likely to have a negative return.

Hmm. That sounds bad.

Check out the article, “How Much You Really Pay for Advice,” for the full read and more on how The Mole suggests you delve into your total costs on professional financial advice.

If you have been meeting with financial planners with the intent of hiring one—or been using a financial planner—I’d love to hear your experiences. Are there some good ones out there that you think have been worth the costs?