Robert C. Lawton
Aug. 21, 2018
Each year, Russell Investments does a nice job calculating the value of working with an investment advisor. They recently estimated the value added as more than 4%.
This is the additional percentage return that investors can expect to receive by working with an advisor compared with going it alone, and includes the following services:
- Construction of a financial plan;
- Basic investment advisory services;
- Tax-efficient investing consulting;
- Help avoiding behavioral portfolio management mistakes; and
- Annual rebalancing.
However, I believe that Russell Investments has left out a number of important elements that make working with a fiduciary adviser much more beneficial than working with a non-fiduciary advisor.
Yes, there is a difference between an investment adviser acting as a fiduciary for advice given and a non-fiduciary investment advisor. That difference is outlined below.
The difference between an advisor and adviser
I’m not trying to be cute. There really is a difference between investment advisers, spelled with an “er” at the end, and investment advisors, spelled with an “or.”
Here it is.
Investment advisers are employed by Registered Investment Advisers (RIAs) (my firm is an RIA) and are required by the Investment Advisers Act of 1940 to act as fiduciaries for the advice they share with their clients. They are the only investment professionals legally allowed to call themselves investment advisers.
Investment advisors, typically employees of banks, brokerage firms and insurance companies, are considered salespeople by the Act. They are NOT required to act as fiduciaries for the advice they share, since that advice should be incidental to the sales process. As a result, most do not act as fiduciaries for the investment advice they provide.
These individuals are not legally able to refer to themselves as investment advisers. Instead, they have decided to refer to themselves using a slightly different spelling of the word substituting an “or” for an “er”. Nearly everyone seeking investment advice is unaware of the difference.
Should you care whether your investment adviser is a fiduciary? Absolutely. It is the most important decision you will make when hiring an adviser. Here’s why.
Why it’s important that your adviser is a fiduciary
Investment advisers are required to put their clients’ interests first when providing advice. Investment advisors not acting as fiduciaries, typically working for banks, brokerage firms and insurance companies, are not.
Non-fiduciary investment advisors are salespeople selling their firm’s products and services and, as a result, tend to recommend investments that pay them more, whether or not they are the best options for their clients.
Investment advisers acting as fiduciaries must always put their clients’ interests ahead of their own. They are legally required to recommend the best options available for their clients, regardless of what they are paid.
As you might imagine, there is a significant difference between the quality of the investment advice that investors receive from fiduciary investment advisers and salespeople.
Can the difference be quantified? I think so.
Estimating the added value of working with a fiduciary adviser
1. No soft dollars
One way advisors can get paid is by accepting soft-dollar, or 12b-1, payments from mutual fund families for recommending their funds. Most fiduciary advisers do not accept these soft-dollar payments. However, most non-fiduciary advisors do.
Eliminating soft-dollar or 12b-1 payments can reduce the expense ratio of a mutual fund by anywhere from 25 to 75 basis points. The additional returns achieved by using a fund with a lower expense ratio flow directly to the investor.
Add another 50 basis points for using share classes that do not have 12b-1 payments tied to them:
4.00% (Russell Investments’ advisor value) + .50% = 4.50%
2. Lowest-cost share class
Investment advisors working for banks, brokerage firms and insurance companies are required to recommend their employers’ investment funds first to their clients — regardless of whether these investments are the lowest-cost, best-performing options.
Investment advisers working in a fiduciary capacity cannot first recommend inferior funds to their clients. They must make the best recommendation possible for their clients. As a result, they generally recommend the lowest-cost share class of any investment. The difference in cost can be an additional 25 to 75 basis points.
Add another 50 basis points for using the lowest-cost share class possible for each recommendation:
4.50% +.50% = 5.00%
3. Lowest-cost broker/custodian/trustee
If you are working with an investment advisor from a brokerage firm, guess where your assets will be custodied and which firm will be doing the trading? If you work with a fiduciary investment adviser, he/she can evaluate and choose the lowest-cost broker/custodian/trustee available.
Investors can save 25 to 50 basis points in trading costs and custody fees when working with a fiduciary investment adviser.
To be conservative, add another 25 basis points as a result of using more cost-efficient brokerage, custody and trust services when working with a fiduciary investment adviser:
5.00% + .25% = 5.25%
4. Competitive investment adviser fees
If you work with an investment advisor from a bank, brokerage firm or insurance company, I challenge you to accurately calculate what you are paying in investment advisory fees. Compensation to these advisors can flow from the firm that employs them as commissions, trails, base comp, bonuses, referrals and reimbursements. These advisors can also receive compensation from any one of 750 mutual fund families, a host of insurance companies and, of course, clients.
Fiduciary investment advisers typically only receive compensation from their clients.
Nearly all the clients my firm has taken on that were using non-fiduciary investment advisors were paying at least 200% of market in investment advisory fees.
If you can’t figure out how much you are paying your advisor because you don’t see all the compensation received, chances are good that you are paying too much. Fiduciary investment advisers have to charge market-competitive rates. Their compensation is transparent.
Because non-fiduciary investment advisors have a compensation stream that is not transparent and because fiduciary advisers have to charge market rates, non-fiduciary advisory fees can be up to 250 basis points higher.
Again, to be conservative, add 125 basis points when working with a fiduciary adviser:
5.25% + 1.25% = 6.50%
As shown in the table below, I believe that investors working with non-fiduciary advisors can increase the return on their portfolios by at least 2.50% by converting to a fiduciary investment adviser. Compounded over the 30 or 40 years investors save to fund their retirements, that can be hundreds of thousands of additional dollars.
Russell Investments added value of an advisor: 4.00%
Plus eliminating soft dollars: .50%
Plus using the lowest-cost share class: .50%
Plus using the lowest cost broker/custodian/trustee: .25%
Plus competitive adviser fees: +1.25%
Added value of a fiduciary adviser: +2.50%
Total value of a fiduciary advisor: 6.50%
In addition, working with an investment adviser acting as a fiduciary can eliminate all conflicts of interest, resulting in higher-quality investment advice.
Why would anyone ever purchase investment advice from an advisor who isn’t a fiduciary?