True Cost of Advisory Fees
True Cost of Advisory Fees

The True Cost of Advisory Fees


In his typically blunt style, Warren Buffet's partner Charlie Munger once remarked that investors don't really understand math and consequently deceive themselves about the actual cost of advisory fees paid to professionals to manage their investment portfolios.

Suppose we assume two portfolios with the same 8% return, but one is charged a one percent end-of-the-year management fee. Would you anticipate your managed portfolio to be approximately 99% of the portfolio without any management fee?

The answer is no! In fact, after ten years, your managed portfolio would only be approximately 90.44% of what a portfolio without the fee would be.

Why??? Not only are you reducing your portfolio by paying the advisory fee, but you are also losing out on any returns that the management fee could have earned. Since returns compound over time, all this adds up quickly.

Even small management fees add up over long periods due to the power of compound returns.

The below spreadsheet illustrates this difference in portfolio values.

Assuming the same beginning balances and equal returns, the only difference is that the advised account charges 1% at the end of each year, and the second account has no advisory fees.

True Costs of Portfolio Advisory Fees
True Costs of Portfolio Advisory Fees

After ten years, the advised account has a portfolio balance of $195,249 or $20,643 less than the account without the advisory fees. Of course, we recognize that the advised fund pays $14,865 in advisory fees over the ten years. This is not insubstantial, but most investors don't realize that these fees also miss out on the 8% annual earnings over the ten years, resulting in an additional decrease in the portfolio's value of $5,778.

The combination of fees paid, and lost earnings due to these fees, results in a portfolio that is only 90.44% of the portfolio without advisory fees.

Some investors must rely on an advisor, and indeed, some advisors earn their keep. However, the age of high fees is well past, and investors can easily replicate some investment-advised accounts with readily available index-related ETFs.

The bottom line principle, whether you decide to use an advisor or not, is at least recognizing the actual cost of those fees. Over time, they may be substantially higher than you may have perceived.

Is it worth it? Only you can decide.

P.S. You may have heard of the "Rule of 72." This rule states that any given investment will double in value over the years derived by dividing 72 by the associated interest rate. Indeed, 72 divided by 8% equals nine years. If you look at the spreadsheet above, the initial $100,000 investment has doubled to almost exactly $200,000 in nine years. This is simply proof of the "Rule of 72."

Note: The information provided on this site is based on my own personal experience and should not be construed as professional advice. I have not been engaged as a financial advisor, planner, or CPA with any reader. The contents of this site and the resources provided are for informational and entertainment purposes only and do not constitute financial, accounting, or legal advice. The author is not liable for any losses or damages related to actions or failure to act related to the content on this website.

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