REP.: What do you think are the biggest mistakes advisors are making these days?
Rick Ferri: Advisors need to really re-evaluate their fees. Advisors tend to believe that they’re worth a lot more than they really are. If the advisor is out there charging 1 or 1.5 percent, in some cases 2 percent per year, to put clients in a simple portfolio of mutual funds, I mean what is that really worth? The fact is, technology is here; advisors can manage many portfolios, take care of many clients in a much more cost-efficient way than they were able to even 10 years ago. None of that has been passed onto the client. The last bastion of gluttony in the investment business is investment advisor fees.
You’ve got Internet companies that are charging 0.25, 0.3 percent that can manage a portfolio as good if not better than all these advisors out there. Individual advisors need to ask themselves, what are they giving their clients above and beyond that? Well, they’re giving them a little bit of hand-holding when the markets go down, maybe they’ll do face-to-face and take them to lunch, give them tickets to ball games. All that’s going to add up to a little more money, but the real nuts and bolts of what they’re doing isn’t much different from what you can get over the Internet for a very low fee.
They have to decide which business they’re in. Are they in the help-the-client business, or are they in the I-want-to-beat-the-market business? They really have to make that decision. The ones who are going to succeed in the long term are the ‘I want to help the client’ advisors, who give up the ego that they’re going to be the ones who time the market and make a lot of money for their clients, get into the right ETFs at the right time, and all that nonsense. What they’re going to do is set up a plan for the client that’s long term, that doesn’t do all this tactical management that’s an ego booster for the advisor but does nothing for the client.
REP.: What do you think advisors are worth? How much should they be charging?
RF: I don’t know any advisor that shouldn’t be charging more than 0.5 percent per year management fee. I think advisors should set what their minimum relationship is going to bring them in per year. So maybe it’s a $1,000 per year. And then you set your minimum account size based on that. You say, ‘If people have $200,000, I’ll take them as a client. If they have less than that, then they need to pay me $1,000 a year, flat fee.’
REP.: Are advisor fees more of an issue today than five or 10 years ago?
RF: Yes, it’s been forced by the economics of the market. The returns of the equity markets have been lackluster, and now interest rates are zero. You’re paying your advisor 1.5 percent per year? For what? If a portfolio of bonds gives you 2 percent, and stocks give you 8 percent, and it’s half and half, your return is 5 percent. If your advisor is out there taking 1 percent of that, they’re taking 20 percent of your profits, if not more. But if the advisor is out there putting you in actively managed funds, which are charging you 1 percent, that’s 2 percent in fees, including what the advisor’s charging.
Advisor fees are part of the equation, and people are beginning to realize it. Advisors have got to address this. It’s not like it was in the 1990s when, ‘Everything was going up, didn’t matter how much. I could charge 1 percent and clients are happy cause the markets going up 20 percent per year and because interest rates are 6 percent.’
REP.: Is this just an issue on the commission side?
RF: No, a lot of commission people are trying to figure out what they’re going to do with the fiduciary standards, and they’re rolling their money over to fee-based accounts. Commissions are really difficult right now. You look at American Funds losing assets; you’re looking at Fidelity losing assets. These are all the commission product vendors, and that’s just not where it’s at. The money is shifting. So the advisors who are trying to survive on commissions, they’re sort of becoming the dinosaurs of the world out there.
REP.: Do you think active management is dying?
RF: What active managers would say, and I’ve seen this all the time, is ‘Well, as more people move to index funds, it gives us more opportunities to beat the market.’ That’s the cliché. There’s been absolutely no evidence of that whatsoever. There’s been no shift in the number of money managers who outperform the market. That’s a fallacy. That’s a hope on the active management side that if enough money gets into index funds, then maybe more active managers will outperform. My question is, if you think you’re going to outperform the market when more people move money into index funds, then who’s underperforming the market? Somebody must underperform the market for you to outperform the market.
REP.: What do you think of alternative investments?
RF: I would love alternative investments if I was an alternative investments manager because I would make so much money on it. It’s the ‘curse of the Yale model,’ which is the idea that you can go out and buy a bunch of alternative investments in a client’s portfolio and they’re going to have a better return. And the fact is, all of these foundations that have adopted the Yale model have underperformed a simple portfolio of index funds. It is a waste of money. To think an individual is somehow going to have access to one of the superior managers is just crazy thinking. And to think an advisor is somehow going to pick the winners from the losers is just crazy thinking. Investing is very simple: There is risk; there is return; there are fees; and there is marketing. Markets are going to produce a certain rate of return for a certain risk, and if you can get that at the lowest fee possible, that’s the best thing you can do. But what we have messing it all up for most investors is the marketing. There is no reason to think that your advisor has superior information. They don’t! They have the same information everybody else has. So why should they outperform? They will get a superior fee if they can convince you otherwise.