Q&A: Fees can do serious damage to your retirement

Dear Liz: When I changed jobs, I rolled my 401(k) account into an IRA and took it to a financial planner. He invested it initially and now has a management company watching it. So now I am paying quarterly fees to him, the management company and the IRA custodian. The fees average about $2,000 a year. I am thinking about moving my account to my current 401(k), which has lower fees.

I feel like the planner has me in way too many investments, and my returns aren’t great. My account is up about $40,000 on a $122,000 initial investment. I will be 60 this year and plan on working for another six-plus years.

Answer: If your employer accepts IRA transfers — and many do — then rolling the money into your current 401(k) could be a great way to go.

Many 401(k) plans offer ultra-low-cost investment options that aren’t available to retail investors. Many also offer target date funds that would take care of diversifying your investments while making sure the mix gets more conservative as you get closer to retirement.

Right now you’re paying above-average fees to get below-average performance. If you had put your money into a low-cost option such as the Vanguard Balanced Index Fund five years ago, your account would now be worth nearly $190,000. The expense ratio for the balanced fund can be as low as 0.08%, compared with the 1.23% you’re paying now. (Your actual cost probably is higher; you didn’t include the expense ratios of the underlying investments in your account.)

Fees matter a lot. Higher fees depress returns and can increase your chance of running short of money in retirement.

At the same time, the years just before and after retirement are crucial because you’ll be making a lot of decisions with major consequences (such as when to claim Social Security and how much to withdraw from retirement accounts). Paying 1% in fees could make sense if you were getting comprehensive financial planning advice that addressed your retirement planning needs as well as other aspects of your finances, such as insurance, taxes and estate planning. If all you’re paying for is investment management, though, you can get that for a lot less.

If your employer doesn’t accept transfers or doesn’t have low-cost options, you could consider transferring your IRA to a custodian that offers low-cost computerized investment services. These include Betterment, Wealthfront, Vanguard Personal Advisor Services and Schwab Intelligent Portfolios, among others. The all-in fee for their services, including expense ratios of underlying investments, is typically less than 0.5%.

If you do opt for less expensive investment management, you still should consider hiring a fee-only financial planner before you retire to review your plan. You can find fee-only planners who charge by the hour at Garrett Planning Network.

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How planners get paid–and how that can, should and will change

iStock_000014977164MediumThe best way to pay a financial planner is directly through fees you pay, rather than indirectly through commissions. That way, you don’t have to worry that the advice you’re getting is influenced by how much your advisor stands to gain by selling you certain investments.

But most fee-only planners have adopted the “assets under management” approach, where the fees you pay depend upon how much you invest with them. And people who think deep thoughts about the industry wonder if that’s the best way to go.

One of those deep-thought-thinkers, Bob Veres of the trade information resource Inside Information, moderated a panel exploring “alternative fee structures” yesterday at the annual conference of the National Association of Personal Financial Advisors, the biggest group of fee-only planners.

There are several problems with the AUM model. One is that the planner’s compensation is tied to the whims of the market—income goes up when the market’s up and down when the market’s down, something that’s beyond a planner’s control. While the complexity of planning tends to increase the more money someone has, planners can still wind up doing a lot for a client who isn’t charged much and “charging a lot and doing not a lot” for another, as one panelist put it.

Another issue is that the planner may be tempted to hoard assets, encouraging you to keep your money invested even if paying down your mortgage, buying rental real estate or investing in a start-up may actually be a better deal.

“AUM has too many conflicts of interest to be the long-term solution for the profession,” Veres declared. He qualified the statement saying it was only his opinion, but he’s got a pretty good track record of predicting financial planning trends.

For planners, the biggest hazard with AUM is that they are charging for what is essentially a commodity—investment management—and throwing in the real value, comprehensive financial planning, for free.

“We are the ones training clients to focus on investment management instead of financial planning” through the AUM model, said panelist and CFP Carolyn McClanahan, who charges a flat fee based on the complexity of a client’s situation. Other panelists based their fee on a client’s net worth or charged by the hour.

Investment management fees are about to get squashed, thanks to so-called “robo-advisors” that use computer algorithms to invest and rebalance portfolios. Start-ups such as Betterment and Wealthfront, as well as established players including Vanguard and Schwab, offer digital advice services for about 30 basis points, or .3 percent. That compares to the 1 percent or so charged by many investment managers (and fee-only planners). Yes, some people will still want a human to manage their portfolio, but in the future fewer and fewer will be willing to pay that premium for it, said McClanahan.

I still hear a lot of scoffing from planners who don’t think robo-advisors will affect their business. A conversation I had with a couple of women who aren’t planners, but who use them, will illustrate that many planners are more vulnerable than they think.

Both women acknowledged that their planners did a lot of work up front, setting up their portfolios and advising them on other aspects of financial life: insurance, taxes, estate planning and so on. But neither felt they were getting enough on-going service to justify their AUM fees, and both were thinking of jumping ship to a cheaper solution. After all, if all they were going to get was investment management, why pay three times more for it? That 30 basis point fee starts to look pretty good. Increasingly, those who charge more will face the burden of proving they’re worth it.

 

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