FREE NEWSLETTER
THE SECURITIES AND Exchange Commission recently proposed that registered financial advisors be compelled to act as fiduciaries when recommending rolling over 401(k) money to an IRA. Whether this rule gets adopted or not, plenty of advisors are eager to help investors with the issue.
Indeed, as I approached retirement, a number of advisors contacted me about rolling over my 401(k). Of course, these advisors also offered to manage my funds for a fee, usually around 1% a year of assets. I joined colleagues at a few lunchtime seminars that were put on by advisors who worked mainly with retirees from our employer. A couple of my friends ended up hiring one of these folks.
These advisors were, I believe, offering sound advice. Some colleagues had no interest in building a portfolio on their own, let alone understanding the complexities of when to claim Social Security or how to manage their income to reduce the Medicare premium surcharge known as IRMAA.
My quibble was with the amount the advisors were charging for their services. Let’s assume an engineer had been contributing to a 401(k) for 40 years, and the company had been matching part of those contributions. It wasn’t unheard of for the engineer to have a $1 million 401(k).
Although there were expenses associated with the 401(k), our company had chosen the plan provider carefully and the costs were minimal. By contrast, an advisor charging 1% of assets per year would be pocketing $10,000 annually from a $1 million IRA.
Let’s assume advisors were charging $500 an hour for their time. That would imply that they should be spending about 20 hours a year to develop a financial plan for you. In your first year as a client, as they get to know you and your goals, 20 hours seems like a reasonable estimate of the time they might spend on your account.
My concern was the second year: Was it really going to take another 20 hours that year, and every year thereafter? Although the advisors we spoke with were suggesting rolling the 401(k) into a series of low-cost exchange-traded funds, there’s a risk some advisors might recommend ETFs with higher fees than we were paying in our 401(k).
What did I do? Did I keep my money in the company 401(k)? Did I hire an advisor? My decision was based on a desire to simplify our finances as much as possible for my wife, should I die before her. I rolled the 401(k) over to an IRA at the brokerage firm we use for our taxable account investments, and then built my own portfolio.
The table below shows the cost of a hypothetical $1 million account at both Vanguard Group and Fidelity Investments, compared with my old employer’s 401(k). While Vanguard and Fidelity don’t offer funds tracking the exact same indexes as the 401(k) provider, you can get pretty close by choosing similar categories. As you can see, by carefully selecting low-cost funds, it was possible to keep costs comparable when moving to an IRA—and there was an opportunity to cut expenses.
Once I completed the rollover, I spent a few hours planning conversions of my IRA money to Roth IRAs, so I’d minimize future Medicare premium surcharges. All in all, I believe I’ve captured 90% or more of the benefit that an advisor might provide, and for a far lower cost than 1% of assets.
You do not need an advisor to manage your assets at 1%. Buy some index funds. The person who knows absolutely nothing about investing may want to hire a fiduciary at an hourly rate to develop an asset allocation and the funds/ETFS within it. Maybe hiring a manager for other reasons may make sense if you feel you know nothing about other financial issues, but not for a % of assets. However, in my opinion worrying about IRMAA is not a reason to hire a manager. For an individual Medicare costs increase if income is over $103,000, $206,000 for head of household. Most will be well below those levels. Aside from converting your IRA to a Roth well before age 70, there is not much else to do to reduce income. I have a substantial 7 figure IRA as well as SS for spouse and me, as well as dividends from investments, and still do not have to worry about IRMAA.
AUM is a carryover from when most FAs were investment managers/advisors. Even then it was highway robbery (similar to the 6% that Realtors charge). Compensation should be related to the work input. The size of one’s portfolio has no relation to the complexity of the account. We do not compensate other professionals in this manner (Lawyers, CPAs, etc.). The faster we move away from this compensation structure the better. AUM also provides a strong disincentive for moving money out of their control, and there are many situations where this is the best course of action.
For FAs it is fantastic! After a bit of work up from, the money rolls in for minimal work thereafter, typically accounts require only minor adjustments after the initial plan is developed. FAs do provide a valuable service and a fixed fee will not be cheap, but it should vary year to year based on the work input to the account.
I also manage my own assets post retirement, but I also worked in the investment business and have some idea of what I am doing. My experience when helping friends and family is that they are overwhelmed by the information available to them and either get frozen in place or sign up for an expensive asset management service that is not likely to pay for itself via superior returns. I’ve looked at too many portfolios where the owner had no idea what they were paying in direct and indirect fees and had no real sense as to how their assets were performing. But the portfolio manager/planner/broker sure is nice! It’s not all that hard to manage our assets if we stick to a few ETF’s and index funds, and most people could benefit from a little asset management education that can often be obtained through their local community college.
My non-Vanguard fund expenses are $250 for a Morningstar premium membership, and in January I will add a membership to New Retirement so I can utilize their Monte Carlo, and their Roth conversion calculator. A lot less than the $10K and advisor would charge.
We use a flat fee FA who also manages our assets. I see most of the value coming from the advice, rather than management of the assets. As far the fees, they have been decreasing as a percentage of portfolio over time. For the investment management piece, the bits where he is likely better than me including the process and timing of building the portfolio back after 401k transfer, rebalancing decisions and strategy of including a TIPs bond ladder and executing it, amongst others. On the holistic planning side there have been many examples over the last few years where he has added value in various aspects of our financial life-I could list them all but I’m confident I would not come close to capturing 90% he provides. He also provides value in getting my wife on the same page, providing continuity after loss of spouse, providing insurance for cognitive decline, providing financial education and providing peace of mind through ongoing professional service. The fees have decreased as a percentage of assets over time and are now around 0.2%, which to me is reasonable, if not a bargain.
I too find the 1% AUM Fee + ER’s to be excessive. Im surprised to hear that an Advisor is currently not required to act as a fiduciary with a roll over. Im thinking that means he/she should act in the owners best interest to analyze and advise if owner should indeed rollover the funds. I kept my 401K with my employer for many years because of the low cost index funds in the plan. Eventually, I moved it all to Vanguard.
In the analysis above (table of costs) it appears you are comparing Fidelity’s Zero funds with Vanguards Index funds. These are not exactly the same. The indexes they follow are close cousins, but the rules with Fidelity will not allow you to transfer those funds to another firm-you would have to sell them. But, if you like Fidelity it is a good low cost option.
Seems like you did a good job. Thanks for the article.
THIS IS NOT FROM ME Joseph Twardoski posted it on my blog
This is off subject but I could not figure out how to ask my question on HumbleDollar.
Rick Dunn stated “In the analysis above (table of costs) it appears you are comparing Fidelity’s Zero funds with Vanguards Index funds. These are not exactly the same. The indexes they follow are close cousins, but the rules with Fidelity will not allow you to transfer those funds to another firm-you would have to sell them.
But, if you like Fidelity it is a good low cost option.”
I am considering rolling my Fidelity 401(k) into a Fidelity IRA. Can you clarify the above? Thanks so much for your help.
I agree that 1% is excessive – though some advisors charge even more. An equitable option could be that a financial advisor charge 1% for the first year during which the heavy lifting of 401k conversions, social security timing, and financial plan generation is accomplished. After that a reduced annual maintenance fee could be charged. Hey, It’s just a thought!
Almost everyone on HumbleDollar – original posters and commenters – can probably do a financial plan and manage it themselves.
But there