Fee Study

In November 2018, I did research to determine the average annual total fee charged by Utah based investment advisors.

Like any new entrepreneur, I knew pricing my services would be essential. An entrepreneur starting a restaurant business selling tacos would want to do research on prices charged by other restaurants in the area who sell tacos. An entrepreneur starting a car dealership selling Hondas would want to do research on prices charged by neighboring dealerships that sell Hondas. I believed the time invested to determine to do this fee study would be worthwhile.

Cost is a crucial component of long-term investing success. John Bogle, founder of Vanguard, exaggerated only slightly when he said in a CNBC interview that “cost is everything in this business.” Cost is more important for consumers in this industry than in other industries.

My first step was to generate a list of all the Utah based firms. To limit the time involved, I only focused on SEC registered firms. These are the firms with over $100 million in assets under management. Firms with less than $100 million in assets under management are registered with their state securities division.

The SEC has an Investment Adviser Public Disclosure (IAPD) page: adviserinfo.sec.gov.
On that page I clicked on the “Investment Adviser Data” link and then clicked on the following URL near the top of the page: https://www.sec.gov/foia/docs/invafoia.htm

I then clicked on the “Registered Investment Advisers — November 2018” link (the most recent link at the time of my study).

Doing this downloaded a spreadsheet with vast amounts of data on every single SEC registered firm in the country. The spreadsheet had over 12,000 rows (representing each firm) and 200 columns of data — the data for each firm came from the ADV 1 document that has basic information like assets under management, number of employees, the firm’s address, etc.

Fortunately, the spreadsheet had a column for “state” and this allowed me to identify all the Utah based firms. I then removed firms that are not traditional investment advisory firms such as mutual fund companies (Wasatch Advisors and Grandeur Peak Global Advisors), private equity firms, and family offices.

53 firms remained. I then looked up each firm’s ADV 2 document and spent many hours carefully reviewing each one. The ADV 2 is a document made available on the SEC’s Investment Adviser Public Disclosure (IAPD) page. The document has information including the types of services the firm offers, the firm’s investment strategies, fee schedule, and more. It is written in a narrative format to make it readable for prospective investors.

I focused on section five on “Fees and Compensation” and tried to determine each firm’s three fee layers: advisory fee, underlying mutual fund or sub advisor fees, and trading commissions. I began inputting the fee data I found into a spreadsheet.

The first fee layer was simple to calculate because firms clearly disclose it. The advisory fee typically drops slightly as assets increase and so I had to settle on a specific asset amount to compare apples to apples. I settled on $500,000. For a $500,000 investment, my data suggests the average annual advisory fee charged by Utah based advisors is 1.4%.

The second fee layer, the mutual fund fee, was more complicated to calculate. Most firms provide guidance in the ADV 2 on the types of mutual funds used to build client portfolios. I thought I could make an educated guess on this second fee layer.

Here’s the approach I took to estimate the second fee layer:

• If the firm only uses broadly diversified, low-cost index funds, then I assumed a 0.1% second fee layer.
• If the firm primarily uses mutual funds from Dimensional Fund Advisors (DFA), then I assumed a 0.4% second fee layer.
• If the firm uses actively managed (no load, no 12b1 fee) mutual funds, then I assumed a 0.7% second fee layer.
• If the firms uses mutual funds that have a 12b1 commission fee, then I assumed a 1.0% second fee layer.

Some firms use a mix of these types of funds. For example, many firms indicated that they use ETFs and actively managed mutual funds. In this case, I assumed a 0.4% second fee layer. My estimate is likely low as my sense is that the ETFs being used are primarily sector based or narrowly invested ETFs that carry a higher expense ratio than broadly diversified ETFs like an S&P 500 ETF (VOO or SPY).

I found that 20% of firms are using high-cost sub-advisor firms to manage client investment portfolios. What I found is that the fee for this service is typically 2.0% to 2.5% and the sub advisor firm gives a portion of that fee to the advisor.

For firms that do not use a sub advisor firm, my estimate is that the mutual fund fee, the second layer fee, is about 0.8%. I believe my assumptions for this estimate are conservative.

The third fee layer includes fees that go to the custodian of the assets (Schwab, Fidelity, TD Ameritrade, etc). These firms make money in various ways, but the main ways are through trading commissions and account service fees. I took a simple approach and assumed that this third fee layer is 0.1% of client assets for each firm. This is likely too low for some firms and too high for a few firms.  Firms that do a lot of trading will likely have a higher third fee layer, whereas firms that take a buy and hold approach with little trading activity may have a lower third fee layer.

Every firm indicates that clients pay for trading commissions and other brokerage fees.

My estimate is that the average total annual fee charged by Utah based investment advisors for a $500,000 investment is 2.3%.

Advisory Fee	1.4%
Mutual Fund Fee	0.8%
Trading Commissions/Custodian Fees	0.1%
Average Total Annual Fee	2.3%

We have a “high fee” problem in our financial system and my study confirmed this reality. The reason we have a high fee problem is that investors in most cases are illiterate in understanding investment fees and their impact on investment outcomes. As a result, they are not demanding lower fees and fee transparency from their advisors.

Webster’s dictionary defines disclosure as “to uncover or reveal.” We have fee disclosure in America because investment advisors must produce and make available the ADV 2 document that discloses fees.

Webster’s dictionary defines transparent as “free from pretense or deceit” or “readily understood.” We do not have fee transparency in the investment advisory industry in the United States.

For many investors, a 2.3% total annual fee does not seem like a big deal. Here’s a table that shows why it is a big deal.

Growth of $500,000 Investment over 30 Years
Initial Investment in 2019	$500,000
Gross Return	6.0%
Total Fees	2.3%
Net Return	3.7%
Ending Value in 2049	$1,487,074
Ending Value in 2049 had NO fees been deducted	$2,871,746

Over a 30 year investment lifetime, a 2.3% fee will mean the “helpers” (advisor, mutual funds) take half the client’s money. That includes half of the contributed investment, not just investment gains. In terms of investment gains, the helpers take 60% of the gains.

The client/investor puts up 100% of the capital, takes 100% of the risk, and only gets 40% of the gains.

There’s a case to be made that the advisor is taking even more of an investor’s gains. Why does someone invest money using the help of an advisor? The answer is to generate a return greater than what is available in a savings account or other risk-free investment. By utilizing the help of an advisor, an investor feels more confident in taking risk. The advisor is an enabler of risk.

In the previous table, the account managed by an investment advisor charging a 2.3% fee grew to $1,487,074 and generated dollar gains of $987,074 over 30 years. However, had the account been in a savings account at an online bank, it could have earned 1.5% or more per year and grown to $781,540 for a dollar gain of $281,540. So the dollar gains in excess of the comparable savings account were $705,534. Had no fees been deducted from the account, then dollar gains in excess of the comparable savings account would have been $2,090,206. So the 2.3% annual total fee meant that 66% of the gains (in excess of the comparable savings account gains) went to the advisor and the mutual fund companies.

(It’s interesting to note that high-cost mutual fund companies only survive because of high-cost investment advisors who put client assets into their expensive, 12b1 distribution fee funds.)

If advisors could generate above average returns, if they could “beat the market”, then they could justify this high fee. But investment advisors cannot generate market beating, risk adjusted returns over time. They may do it for a year or even a few years, but overtime they won’t. The returns they are able to generate, over the long term, are capped by the returns generated by the overall global stock and bond markets.

My fee study coincided with my reading of John Bogle and the Vanguard Experiment by Robert Slater. It’s an out of print book that tells the story of John Bogle and the founding of Vanguard. Reading the book was a game changer for me for two reasons. First, it convinced me there is a “no man can serve two masters” problem in the investment business. High profits for the mutual fund company or investment advisor will mean lower profits for the mutual fund investor or the advisor’s client. There is an inherent conflict of interest whenever money is managed or invested for someone else. The book opened my eyes to this reality.

Second, the story and example of John Bogle had a deep impact on me. I was so inspired by his lifelong efforts to protect and serve the best interests of American investors. I believe he is the best example of what it means to be a “fiduciary”. He found a structural solution to the no man can serve two masters problem. He formed a mutual fund company with no outside shareholders. The mutual fund investors would own Vanguard, and any profits generated would be translated into lower fees for the Vanguard mutual funds. Today, Bogle’s pioneering work is saving American investors at least $100 billion per year in the form of lower fees. Bogle solved the conflict of interest problem from the top at the mutual fund level. If we solve the conflict of interest problem from the bottom at the investment advisor level, then we can save American investors an additional $200 billion or even $300 billion per year in the form of lower fees. Over 10 years, the fee savings for American investors will be in the many trillions of dollars. The gross return earned by American investors will not be impacted, but the net return will be higher. This is one way we can significantly improve retirement outcomes for American investors.

One of Bogle’s ideas that has stuck with me is the idea of “reasonable compensation.” He believed fees should meet a reasonableness standard. Advisors who work in the industry should not amass great wealth because their work does not generate or grow wealth in our economy. Wealth is created through productivity growth and entrepreneurship from from other industries in our economy. It comes from Uber drivers transporting people around, auto companies manufacturing cars, restaurants serving food, technology companies writing innovative software, truck drivers moving freight, doctors and nurses providing medical care that extends life and quality of life, plumbers fixing broken pipes, construction workers building roads, and mechanics fixing airplanes. This is the work that grows our economy and creates wealth.

Investment advisors merely give advice, and help people invest money and plan their finances.

The industry advisory industry allows (or should allow) Americans to invest their assets in a way that helps them “participate” in the growth of the economy.

An investment advisor is therefore capped in his or her ability to add value because the advisor does not help to generate wealth. Rather, the advisor merely helps investors participate in economic growth and harness the power of financial markets. The advisor can therefore only add value by helping the investor promote tax efficiency, instill long term investment discipline, manage risk appropriately, and help with financial planning. The potential “value add” is capped and so I believe advisors should be working for reasonable compensation.

Our DIY Investing Service is an “advice only” approach. It is a onetime fee of $800 and involves about 15 to 20 hours of work on our end. As we build our name and reputation, we will increase this fee to perhaps $2,000 to $3,000. This would be $100 to $150 per hour. We believe this meets the “reasonableness standard” for compensation.

Our ongoing investment management and financial planning service is $3,000 per year, per client relationship. The fee will stay constant for 10 years even as inflation rises over that period. We have estimated that providing this service will involve about 20 hours of work per year per client. We believe our $3,000 per year fee meets a reasonableness standard.

Fees of course aren’t all that matters in a financial planning or investment advisory relationship. However, we believe our fee structures and commitment to evidenced based investing empower us to be true practitioners in our field. We will continue to work diligently to sharpen our financial planning and investment advice skills. Building a firm that combines fair fees and good advice is our goal.