Retirement Investing And Four-Letter Words

The four-letter word that comes to mind most quickly when one thinks of retirement investing is probably “save” followed quickly by “more.” But I have another word in mind — “only.”

That’s the four-letter word used by Charley Ellis, widely known as the dean of retirement thinking and author of the investing classic Winning the Loser’s Game. Charley uses it as an ironic modifier in front of the percentage amount that many people pay in investing fees.

“Only” 1%. That’s what the active fund managers tend to argue. Don’t worry, they tell you, we’re not taking a lot of your money. It’s “only” a tiny slice.

I am here to tell you that “only” is a dangerous and misleading word. Because it’s not true at all.

When a financial advisor says he or she is “only” charging you 1%, the immediate question that you should ask is, okay, 1% of what?

The answer is: 1% of your assets. When we think of 1%, we picture a penny. That’s what 1% of a $1 is. But we don’t have $1 in retirement savings. Usually, it’s much more.

Let’s scale that up, then. If you have $10,000 saved in your 401(k) at work, then 1% of that money is $100. If you have $20,000, it’s $200.

Okay, you might say, I don’t expect my financial advisor to work for free. Nevertheless, you do expect your financial advisor to make a difference. You expect him or her to help you beat the market.

In practice, however, that doesn’t happen. Most actively managed funds struggle to keep up with the markets, especially after you subtract their fees. Here’s where the “only” part kicks in. The fee is not charged on your gains. It’s charged on your total assets.

If the stock market returns 5%, your portfolio is now up $500. But you pay the advisor $100. That’s 20% of your gain! In simple terms, 100 is one-fifth of 500. (Technically, you pay a bit more, since your portfolio rose in value: $105).

Scale it up again. Say you have $100,000 in an IRA. You now pay your advisor $1,000 a year to watch your money. The market delivers a 5% gain, so you get $5,000. And promptly pay your advisor his or her a 20% cut of your investment gain — $1,000. Plus $50 more.

Say the stock market declines. Your portfolio falls in value to $85,000. You might have the financial will not to panic and sell, so there’s no loss.

Still, you pay your advisor $850 that year. Remember, the fee is based on assets, not gains. It’s not performance-based at all. It’s heads-they-win, tails-you-lose.

Retirement investing trust

Arguably, a good financial advisor can help you avoid those panic moments. He or she can and should be your partner in long-term planning, too. And the assets-under-management model is not the worst way to compensate a trusted advisor.

After all, it aligns their goals and yours: More money in your account at retirement is better for both of you. It also motivates a good advisor to help you avoid unrecoverable losses, especially right before retirement.

Nevertheless, be very wary of the absentee advisor, the person who signs you on to a high-fee arrangement and then disappears into the woodwork. If it’s hard to get your advisor on the phone or, worse, you cannot even remember his or her name, that’s a bad sign.

It’s “only” your retirement, after all.