How Advisors are Paid​​

​Commissions. Traditional stockbrokers and insurance agents generally get paid a commission for products they sell you. Because they're paid by the firms that offer the products, there's usually no charge to you. But there's a potential conflict of interest with the model. Any time someone is paid a commission, you're never sure whether they're operating with your best interests in mind or their own.

Fee-only. This is on the opposite end of the spectrum. Registered Investment Advisors (RIAs) don't accept commissions and they are paid by their clients. Fee-only advisors can be paid hourly or charge a fixed periodic fee. However, the most common way fee-only advisors are compensated is calculated by taking a percentage of the client's assets under management. Fees in my industry average somewhere in the neighborhood of 1% of assets up to about $1 million. For example, if you had assets under management totaling $1 million and you were charged 1% on those assets, the advisory fee would be $10,000 per year. 

Fee-based. This is a combination of the two categories above. A fee-based advisor charges a fee but also accepts commissions. The  potential for a conflict of interest still exists with this model, but it's usually smaller, since the advisor's income does not consist entirely of commissions.

My take: My business is organized as a fee-only Registered Investment Advisor (RIA). I believe commissions create an inherent conflict of interest because you're never sure if someone is recommending the option that's best for you or the option that pays them the highest commission. I'm paid only by my clients and recommend only what's best for them. I don't compete on price but I try to keep my fees at or below the average in my industry, unless it's a very small account or very complex account. 

The Fiduciary Standard​

All financial advisors are not held to the same standard of conduct.  Financial Advisors who are fiduciaries have a special relationship of trust with their clients. They are required to put their clients' interests ahead of their own.

Some financial advisors, such as traditional stockbrokers, do not have to put their clients' interests first, and are held to a lower standard where they only need to select investments that are "suitable". 

Furthermore, many traditional brokers earn commissions on the products they offer, sometimes making it less than clear whether they're picking an investment because it's best for you or because it's best for them.​

My take:  I hold my business to the fiduciary standard. While there are plenty of honest and ethical financial advisors who are paid on commission, any time someone other than you is paying for the advice you receive, there's an inherent conflict of interest. 

The CFP® Designation
"CFP" is an abbreviation for "Certified Financial Planner", usually written CERTIFIED FINANCIAL PLANNER ™ (in capital letters with a "TM" symbol) to comply with the branding standards of the CFP Board, the organization that owns the trademarks. It's a professional certification held by less than a third of all financial advisors. To earn this designation, you have to complete a series of college-level classes and sit for an all-day exam with about a 60% pass rate.

 While there are many ways to develop expertise that don't involve passing a test, completing this certification indicates the recipient has been through a rigorous education process and has expertise in several critical areas of financial planning, including investment management, estate planning, taxes, education funding, and retirement planning.

My take: I earned this certification later in my career, after I had already built up a significant amount of practical experience. Nevertheless, I still learned a fair amount that I didn't already know, and definitely benefitted from the time I spent studying for it. I wouldn't rule out an advisor who doesn't have this designation, but I'd give those who do have it a few extra points for the stamina and determination it takes to complete it.

Where I Keep Client Accounts

As a fee-only advisor, I'm free to hold assets at any brokerage firm that best serves my clients' needs. In practice, however, it's very difficult to have accounts at more than one place, and most advisors have a relationship with one firm where they hold the majority of their clients' investments, a practice called custody. 

I maintain most client accounts at Vanguard. They are known for offering very low-cost investment products and have a very large lineup of inexpensive index funds, which have garnered a large and growing share of investor assets in recent years. They are also very efficient at managing uninvested cash, which turns out to have a non-trivial impact on overall portfolio performance.​

My take: Low-fee index funds are increasingly becoming the vehicle of choice for advisors and their clients, and I will help you open accounts at the firm that offers you the best overall value.

My Territory
I live and work across the bay from San Francisco, in a smallish town called El Cerrito. I'm registered with the State of California and most of my clients are California residents within driving distance. Like many other industries, financial advisory firms are increasingly taking advantage of technology that makes in-person visits less necessary. That said, mine is still a very personal business and it's nice to meet with my clients face to face occasionally.

My take: Although I don't rule out clients who live in other states, regulations limit the number I can accept and I'd still like to meet you in person.

My Office

I used to have an office in Downtown San Francisco’s Financial District and I regularly commuted to work like everyone else. However, I noticed over time that I rarely met with my clients in the office, because driving downtown to meet with me could be stressful and parking was expensive. More recently, technology has allowed me to do the majority of my work online, leaving in-person meeting time available to discuss more important things than paperwork, such as goals and dreams for the future. This can be done at any convenient location over coffee, lunch, or a glass of wine.

I now rent office space when I need it and not when I don't. It's called coworking and it's very popular with many smaller companies and startups here in the San Francisco Bay Area.​

My take: The world has changed a lot and I've changed with it. Virtual offices and coworking have come of age and are here to stay. I meet with clients at a time and place that's convenient for them and, more often than not, it's outside of a traditional office atmosphere.

Active vs. Passive Investing

Active investing is what comes to mind when many of us think about investment management. A broker calls us with a hot tip on an investment that's supposed to do better than the market, a recommendation presumably backed by extensive research that the broker's team did on things like the prospects for an individual company, trends in an industry, or the performance of the economy as a whole.

The goal in active investing is to produce a rate of return that's better than the return everyone else is getting, usually referenced by some benchmark or index, like the S&P 500.

In contrast, passive investing simply buys all of the stocks tracked by a particular index, a process facilitated by numerous mutual funds and exchange-traded funds that have been specifically developed for this purpose. These index funds have very low fees and, by definition, produce a return that's very close to the index they're tracking.

Very few doubt that active investment can produce higher returns, but it's important to understand that it takes additional time and energy to do all the research and investigation required to produce those higher returns. And that time and energy is inevitably reflected in the expenses charged by a fund. The basic equation works like this:

Overall rate of return on a fund = the rate of return on the underlying investments of the fund minus the expenses charged by the fund

And this is where the science is starting to become pretty clear: A fund that tracks an index and  has very low expenses tends to produce a higher rate of return than an actively-managed fund with higher expenses.

My take: Most actively-managed funds don't outperform their index after fund expenses are subtracted. Low-cost index funds offer a straightforward and easy-to-understand way to invest over the long term. 

Asset Allocation

Investments are not one-size-fits-all. Each investor is different and sometimes an individual investor could have more than one goal with different investments for each. For example, a person in their 20s might feel very comfortable investing in the stock market for their retirement several decades down the road, but might prefer to keep their money in a bank account when saving for a wedding that's only a few months away.

Asset Allocation involves selecting a mix of various types of investments to match a client's financial goals and personal preferences.

For most individual investors, the major asset classes are stocks, bonds, and cash (including bank and money market accounts). There are sometimes subcategories as well. For example, within the stock category there are international stocks, domestic (US) stocks, large company stocks, small company stocks, etc.

A rigorous asset allocation strategy involves identifying the various asset categories to be used and adjusting the proportions of each to match a client's specific needs.

• Riskier investments, like stocks, tend to produce a higher rate of return and are more appropriate for longer-term goals, where the investor can "wait out" temporary downturns in the value of the investment.
• Less risky investments, like bonds and bank accounts, tend to have a lower rate of return and are more appropriate for shorter-term goals where maintaining the value of the investment is more important than the overall return.

Lastly, a person's individual tolerance for risk also has a direct impact on the appropriate asset allocation. Where one investor might feel very comfortable sitting tight if the value of their investments dropped significantly, another person might be inclined to sell their investments at a loss if they started to lose money.

There is no right or wrong answer to any of this. Each investor can have a different tolerance for risk and even two investors with the same tolerance for risk might have goals with completely different time horizons. All of these factors must be taken into consideration when selecting the proper investment allocation.

My take: Selecting the proper mix of investment types is probably the most important single decision an investor makes and it's one of the areas where a financial advisor provides the greatest benefit. It's actually more important to an investor's long-term success than the specific investments selected.​

Portfolio Rebalancing

Once a proper asset allocation is selected, it must be continually monitored. Individual investments can move up and down in value relative to one another, leaving a portfolio with different proportions in each investment category compared to when the portfolio was initially set up.

Periodically, you need to sell some investments and buy others to bring the asset allocation back into alignment. This process is called rebalancing and it's a necessary maintenance task that's sometimes misunderstood and sometimes ignored.

Why is rebalancing important? It has to do with the old adage about buying low and selling high. It's very difficult in practice to know when to buy and sell an individual investment. If it's appreciated in value, you may decide to sell it take the gains. Or, you may decide  to hold on to it because you think the price will continue to go up. The same thing happens when the value of an investment goes down. Do you buy more because the price is low or do you sell what you already own before you lose even more? Everyone who's ever invested has struggled with these questions -- even the professionals. And it turns out the professionals aren't any better at coming up with the proper answers than anyone else is.

Rebalancing a portfolio is a much better way to buy low and sell high than guessing about the price movements of an individual investment. For example, you might own a stock fund and you might not have a very good idea whether it's expensive or inexpensive. But, if you own a stock fund and a bond fund, and both fluctuate in value relative to one another, you can establish a rule to buy the fund that's inexpensive relative to the other and sell the fund that's expensive relative to the other. This is exactly how rebalancing works and it's been proven over time to be a much better way to buy low and sell high than viewing an individual investment in a vacuum.

My take: Rebalancing is a systematic and disciplined way to determine which investments should be bought and sold in a portfolio while maintaining the level of risk at an agreed-upon level.

Behavioral Finance

I put this one later in the lineup, even though it's actually significantly more important that some of the other topics I've covered. There's a lot of what I would consider "hard" science behind some of the earlier discussions. Although the subjects are sometimes complex and difficult to summarize, they can be demonstrated using tools like mathematics, which gives them extra solidity and weight that they possibly don't deserve.

A field called behavioral finance uses psychology to understand the behavior of investors and, in particular, it studies psychological biases that allow our brains to perform well in certain situations (like avoiding hungry lions), but which actually undermine us when it comes to investing.

Traditional finance assumes that investors behave rationally and economists really like this assumption because it makes their equations balance nicely. In the real world, however, it's pretty obvious that we don't always behave rationally.

There are a multitude of behavioral biases that can undermine a successful investment strategy and one of the areas a financial advisor can help most is by creating awareness of these biases and implementing strategies to help overcome them or work around them.

Here are some common examples that you might have come across in your travels:

• The guy who bought Facebook years ago and thinks he's an expert investor as a result. Is one investment success really enough to make him feel that confident? What other investments did he buy that didn't do as well?
• The lady who bought bitcoin because everyone else was buying it and she didn't want to miss out. Is she sure it's a fundamentally a good investment? Can we think of situations where large numbers of people shared an opinion and still turned out to be wrong?
• The guy who watched the market go down and sold everything. Was it a crash or just a routine downturn? Even if it was a crash, did he need the money immediately or could he have waited it out?

There are many, many others.

My take: On the surface, it might not seem obvious that psychology has a lot to do with investing, but it actually has a huge impact on an investor's success over the long term. Good investment advisors not only recognize this but study it deeply and incorporate it into every client interaction.

Comparing Prices
Financial services firms and the investment advisors who work for them can charge fees in many different ways. If you're comparing two different options, it's important to have a methodology to do a fair side-by-side price comparison.

These are the steps that I go through with prospective clients to help them tally up the total fees they're paying at their current firm. It assumes you have a year or more of statements to review to be sure you haven't missed anything. An annual statement is often available and is sometimes easier to review than numerous monthly statements.

These are the steps to follow for each option you're considering to get to an approximate total annual dollar figure for each.

Step 1
Check the statements for any transactions with the word "fee" in it. These are explicit advisory fees, often referred to as "wrap fees", that are deducted directly from your account. These go to your financial advisor and the firm that they work for. These fees are often charged quarterly, so it's important to review transactions for an entire year to get the proper annual amount.

Step 2
Look at the underlying investments. If the underlying investments are mutual funds or exchange-traded funds (ETFs), there are also fees charged on the funds themselves. Use the ticker symbol to find the prospectus or locate the fund's web page. Funds sometimes have many different share classes and each share class has a different fee structure, so be sure to note the share class being used. The prospectus for a fund can be thick and intimidating, but the government kindly requires all fund companies to disclose fees clearly at the beginning of the document, so they are fairly easy to find.

If there are multiple funds in an account, check to see if each fund is same share class. If so, you can simplify the estimate by taking the largest holding and assuming the entire account is invested in that one fund. Usually, all the funds in an account are held in the same share class, and have similar fees. If they aren't held in the same share class, you can calculate fees separately for each investment.

• "12b-1 fees" are paid to the advisor. Most of these fees are paid annually, but they are sometimes charged either at purchase or at sale. If there are one-time fees, you should really distribute them over the life of the investment, but you can simplify by lumping everything into a single year and assuming the fund was bought and sold in the same year.
• Any other fees in addition to the 12b-1 fees are kept by the fund company.

Individual stocks like Amazon or Boeing don't have expenses, so you're looking for the fund expenses only when the underlying investment is a mutual fund or exchange-traded fund (ETF).

Step 3
Look for trading fees and commissions. These show as transaction charges that are deducted when you buy and sell investments. These "ticket charges" are paid to the brokerage firm when you buy or sell an investment. In some cases, these transaction charges can be pretty substantial but competition among brokerage firms has increased significantly in recent years and they are sometimes as low as a few dollars per trade. Be sure to factor them in anyway, just to be sure it's a fair comparison.

Step 4
Add up all the fees paid in a year and review the total figure. This number is often larger than people think.

Examples
Let's do a few examples, based loosely on statements I reviewed recently. I adjusted the account size in each case to make it exactly $400,000, since some of the fees vary based on the size of the account. I also made the advisor's fees the same in each example, to focus more on the fund fees. In reality, one advisor may charge lower fees than another, and you would also capture that important  difference in the analysis if it were to happen.

The examples weren't chosen at random. The first two represent typical commission or fee-based investing arrangements. The third example is a fee-only arrangement similar to mine.

Example 1: Account at an Independent Advisory Firm

Step 1: I found an explicit charge each quarter of $1,000, listed as "fees & charges". $1,000 x 4 = $4,000 for the year to the advisor.

Step 2:The investments in the account consisted mostly of mutual funds from American Funds. The largest holding was the "Growth Fund of America CL F2", ticker GFFFX. The "CL F2" part is the share class. I looked up the fees for the Growth Fund of America F2 share class on the American Funds web site and also double checked the prospectus for the fund.

• There were no 12b-1 fees. That makes sense because the advisor was paid an explicit charge in step 1 above. Hopefully, they’re not getting paid twice (once by the client as a fee deduced from the account and again as a commission paid by American Funds).
• Management and other fees: 0.42% (at the time I wrote this) 0.0042 x $400,000 = $1,680 per year

Step 3: I found funds being purchased and sold but no transaction fees on the account.

Step 4: Total fees are $4,000 + $1,680 = $5,680 per year.

Example 2: Account at a Large Bank

Step 1: I didn't find any explicit charges for advisory fees on this account, but the account owner had an advisor at the bank. The advisor's fees are in Step 2 below.

Step 2: I found American Funds again as the principal investments in the account, but this time "Class C" shares. The largest holding was the "American Balanced" fund, C shares.  I again went to the American Funds web site and to the fund prospectus to get the fees.

• 12b-1 fees of 1% we listed. These are collected by American Funds and passed along to the advisor, and this is how the advisor is compensated in this case.
• Fund operating expenses of 0.36% (as of this writing) were listed. These are paid to American Funds.
• Total fees of 1.36% are paid to American Funds and the 12b-1 portion is paid to the advisor.

Step 3: I found funds being purchased and sold but no transaction fees on the account.

Step 4: Total fees are just the fund fees of 1.36% on $400,000 or $5,440 per year.

Example 3: Account with a Fee-only Investment Manager

Step 1: There were no advisory fees charged directly on the account, but the client received invoices directly from the advisor, totaling $4,000 per year.

Step 2: I reviewed holdings on the statement and the advisor used Vanguard exchange-traded funds (ETFs) as the investment vehicle. The largest holding was "Vanguard S&P 500 ETF ", ticker symbol VOO. After looking up this fund on Vanguard's web site, I found:

• No 12b-1 fees.
• Total expense ratio of 0.04%. 0.0004 x $400,000 = $160 per year.

Step 3: The portfolio was rebalanced once per year, requiring six trades at $4.95 per trade or about $30 per year in transaction fees.

Step 4: Total fees are $4,000 + $160 + $30 = $4,190 per year

My take: At first glance, the fee-only advisor in example 3 might seem more expensive, since the client is billed directly and is writing a check for $4,000. In addition, the client is also paying $30 of transaction fees, which you don't see in the first two examples. However, the American Funds fees in the first two examples, although less conspicuous, are larger and just as real. In contrast, the Vanguard funds used in the third example had much lower expenses. As a result, the overall fees paid by the client in the third example were significantly lower, even though the advisor was paid exactly the same 1% of assets or $4,000 per year in each case.

Active vs. Passive Investing By the Numbers

I’ve done a couple of examples on this page where I’ve compared expenses on two different funds side by side and invited you to consider whether the fund with the lower expenses might be a better value. But you might also be wondering if the fund with the higher expenses also had a higher return. It would make sense if it did, right? You get what you pay for and, if you pay more, you should  get more. This has been the subject of a lot of debate over the last few years and you can read copious amounts about it it on the web if you google “active vs. passive funds” or something similar.

Types of Funds

• Actively-managed funds are mutual funds or exchange-traded funds that hire professional money managers to pick investments for them. These funds have higher fees because they have to compensate these managers for their time and expertise.
• Passively-managed funds simply buy lots of everything, usually by purchasing the same investments that are tracked by an index. The most recognizable index is the S&P 500, which tracks the stocks of 500 large American companies.

I wanted to pick one of the larger funds in each of these two categories and compare the expenses and returns side by side. If you wanted to be really scientific, you'd need to include more than just two funds. I've actually done much more detailed and tedious versions of this analysis and I and up drawing the same conclusions.

The Growth fund of America is an actively-managed fund offered primarily through investment advisors, so I picked the class F shares for the comparison. This share class is designed for accounts that charge advisory fees as a separate expense, so the figures do not include any expenses paid to an advisor (12b-1 fees). But it does include expenses paid to the fund family for operations and administration.

The Vanguard S&P 500 Fund, is a passively-managed fund and also contains only expenses charged by the fund family for operations and administration.

The information for both funds, therefore, contain the same general categories of expenses.

The final column, labeled "10-year Return Without Expenses", is the sum of the two columns to the left of it. It's essentially what the return of the fund would have been without expenses. This is a valid way to work the math, because fund returns are reduced by exactly the amount of the expenses charged. Just as you can calculate actual return of the fund by subtracting expenses from the overall return, you can also start with the actual return for the fund, add back the expenses, and calculate what the returns would have been if the expenses had not been charged.

One thing that jumps out is the figures for the 10-year returns without expenses for the active and passive funds are very similar to each other (16.10% and 15.94%, respectively). This is because large actively-managed funds buy many of the same investments the passive funds do. In the case of large company stock funds, you can look at the list of top holdings and see a lot of overlap. The largest holdings in the S&P 500 are companies like Microsoft, Apple, Amazon, Alphabet, and Facebook, and these are many of the very same stocks owned by the active funds.

 Another thing that jumps out is that the actual returns in the first column are materially different between the active and passive funds (15.41% and 15.90%, respectively). This difference is largely accounted for simply by factoring in the higher expenses that were subtracted from the active fund's return. (By the way, half a percent difference in return is material. It can add up to a very big number over time.)

My take: Actively-managed funds CAN produce better returns, but their expenses are also higher. This is because they have to pay for all the staff, facilities, and equipment necessary to do all the additional research. After the expenses for those things are taken into consideration, actively-managed funds tend to underperform passively-managed funds and their corresponding index.

Budgeting Sucks
I don't know how to say it any other way. I've created a lot of and traditional budgets for clients and they never seem to work.

There are many reasons for this, but I think the main one is that budgeting is a very unsympathetic process. You look at things you're spending a lot of money on and reflexively assume you need to cut back on them without asking if the money is well spent or not. Then, you tighten the belt by making monthly spending goals, track yourself against those goals, judge yourself when you fail, and then do the same thing the next month.

Very few people enjoy doing this.

Budgeting isn't an absolute process. It's inherently a tradeoff that can best be expressed by asking three questions at the same time:

1. Where am I spending the most money?
2. Is the money I'm spending going toward something I really, really enjoy?
3. How will my future self feel about the money I'm spending now? Will I say "I'm so glad I bought that mutual fund when I was in my 20s." or "Damn! I should have bought that Tesla when I was young enough to really appreciate it."

For example, if I enjoy taking cooking classes and I don't spend too much money on them, I'll probably never regret it down the road, especially if I'm still using and enjoying the same recipes years later. On the other hand, if I have a cable subscription that I spend a lot of money on and I don't really watch much TV, maybe the money could be invested today and used to buy something more meaningful down the road.

The first question in the list above is where the most time and effort is spent in the traditional budgeting.

More enlightened versions grant that there is also a place in the process for the second question.

The third question above is the trickiest. It involves a well-known and much-discussed tradeoff between current and future consumption that goes something like this: "If you give up one cup of coffee today you can have ten cups of coffee down the road."

Most people I expose to that wisdom aren't very impressed with it.

On the other hand, if I could say something directly about the type of spending they're doing like "College is a waste of money. Everyone looks back and regrets it." THAT would impress people (assuming I could substantiate it).

I recently found a survey by Schwab that directly addresses categories of spending that real people feel they would have spent less on, if they had it to do again. I now have three dimensions in my budgeting process and the third column in the table below is loosely based on the Schwab survey results.

I'm having a fight with my Compliance Department about how much disclaimer and warning I need to subject people to before they click an external link on my site. For the moment, you can contact me by email if you'd like a copy of the survey I'm referencing. It's a light and interesting read.

This table is an example of the Prosperity Assessment I mention on the home page. I don't call it budgeting on the home page because people would immediately click away.

By the way, these are all discretionary spending categories. It's also possible to find savings in non-discretionary categories like mortgage and groceries, but that's not included in this example.

Green = Spend more money here
Yellow = Keep an eye on it
Red = Spend less money here

My take: No one likes traditional budgeting. Contact me instead for help completing a Prosperity Assessment. It's more than just a budget with a different name. It's a respectful, non-judgmental process and inherently recognizes that spending is a tradeoff. The goal isn't to tighten the belt. The real objective is to spend more money on things you truly value and less money on things you don't. It's usually possible to achieve goals for long-term prosperity without cutting back on the most valued things in life today.

Return and expense figures are from the Vanguard and American Funds web sites in early 2019

​Simple Life Financial