Rick Ferri: Advisor Fees Are 'Last Bastion of Gluttony' in Investment Industry

Charging an hourly fee or a subscription where the client pays a small monthly amount for ongoing advice as they need it, or a flat fee, regardless of how much money they have, if you're going to do advice plus portfolio management.

A lot of advisors are doing that now — charging a flat quarterly or annual fee and giving the client unlimited advice.

What do AUM- and commission-based advisors say in objecting to your views?

They try to justify their fee: "You have to measure the value we add" and "We're entitled to a portion of that value added — what we do makes money for the client, so we're entitled to a portion of that money," they say.

But that's not true. An advisor is like a CPA: They do your tax return but aren't entitled to a portion of your refund [if you get one]. Advisors aren't entitled to a percentage of the financial benefits the client gains from the portfolio.

What do you propose, then?

The way you solve the problem with the advisor who does quote-unquote money management and advice is to charge a flat annual or quarterly fee or even a monthly fee. And it doesn't change based on the amount of money the advisor is managing.

The first track is complete separation between the advisor who's giving the advice and the advisor who's managing the portfolio. The advice-giver gets paid an hourly fee or a retainer or subscription.

The second solution, if an advisor is doing both advice and portfolio management, is that you have to structure the compensation so that regardless of the advice they give, they get paid the same amount of money. 

You can do a flat family fee of $8,000 or $9,000 a year.

What else do you think is wrong with the way advisors handle their fees? 

A fiduciary advisor has a legal responsibility to review costs in a client's portfolio every single year. But they'll skip over their own fee whenever they come to it. They won't address their own fee ever.

If the client complains about the fee, the first thing the advisor will say is, "That's the industry standard," which is nonsense.

There's no such thing as a standard fee. That might be the average fee, but it's not the standard, because there's no standard fee in the industry.

If the client argues some more and the advisor thinks they're going to lose the client, they'll give them a break and reduce their fee somewhat. 

But no advisor is ever going to come to the client and say, "You know, we've decided that 1% is too high now, and we're going to reduce our fee."

When they seek you out, what do investors need help with most?

No. 1, they come with a very complicated portfolio, most of the time put together by an advisor, and they want to make it simpler: They might have 25 to 50 funds that are really a mess, and they want to consolidate that into a few good low-cost funds.

Why else do they come to you?

For validation or confirmation that they have a good portfolio they've been self-managing. They want confirmation that they're doing it right.

The third thing is when people are getting ready to retire, they want to make sure they'll be distributing their money well — whether they should be doing IRA Roth conversions, when to take Social Security — and how it all integrates into a distribution plan, including how to pass the money on to the next generation.

Is promoting index funds part of the advice you give?

I'll make a recommendation. If the client is at Fidelity, there are Fidelity index funds they could use. If they're at Schwab, they might use Schwab index funds. If they're at Vanguard, they could use Vanguard funds. 

Or it could be a mix-and-match — whatever makes sense for the client. You can buy Vanguard ETFs through Fidelity or Schwab.

Where do you see active management headed?

The big thing right now is that active management has figured out ways to create actively managed ETFs and distribute their product through them.

This has helped drive down the cost of active management because the cost of running an ETF is less expensive than the cost of running a mutual fund.

An ETF saves active investors money, and that helps cut underperformance. So active management fees have been coming down, and ETFs are helping that.

Do you think that active managers' performance will improve?

It's feasible that active management will do a little better relative to the indices going forward.

But on the flip side, you've got some really smart people that are going into active management. The quality of management has gotten a lot better over the last 25 years. So the competition has gone up, which makes it tougher.

(Photo credit: Kristin Gladney)