Today’s discussion is we’ll center around what I viewed to be the outrageous or disingenuous percentage charge.
Welcome to our listener supported podcast Money Talk. Uncompromised absolute financial truths behind financial perceptions. With hosts Ed Sutkowski and Chuck LeFebvre. Let’s listen in.
Chuck: This is Chuck.
Ed: And I’m Ed, and today’s discussion is we’ll center around what I viewed to be the outrageous or disingenuous percentage charge. We’re going to make a lot of friends here Chuck.
Chuck: Yes, Ed’s had a rough week working with banks.
Ed: I’m confident that I’m going to have gazillion peoples when I’m buried, only because they’ll make sure I’m dead.
Ed: Aside from that we’ll tell you about the registered investment advisor, the corporate executive compensation. Likewise a not for profit executive compensation. Executor and estate administration fees. The realtor charge, and the lawyer, personal injury and workers comp.
Chuck: Boy, we’re hitting close to home.
Ed: Yes, as I say we’re not going to make too many friends here, but that’s okay.
Chuck: We’ve talked about some of these guys before. Especially the investment advisor.
Ed: Yes that’s a good point, and want you to know that we’re going to talk very little about the investment advisor and refer you to episode 15. Fees, cost and expenses. That’s the basic episode. We’re just going to go over that a little and expand about that with reference to events that occurred since then. Specifically I’ve found that the investment advisor uses that holistic approach. We’re going to be your psychologists, your psychiatrists, your estate planner, everything. Is that fair Chuck?
Chuck: Well that’s what they say, but my own experience is that that is much more of a marketing message than it is an actual– Where these organizations very rarely have the staff and the training and the infrastructure in place to actually deliver on that promise. It just sounds great, and of course the reason they say it is because they have to somehow justify these fees.
Ed: We’ll get to that. It’s interesting. Now they’re starting to actually do income tax returns, and we’re seeing the accounting firms becoming these registered investment advisors.
Chuck: Yes, that’s very widespread. That’s more widespread than the investment advisors getting into the tax return preparation. Yes, there’s very much this sense of– I think that the industry and people in the industry know that people look at the cost associated with these investment advisory services, and they have a hard time swallowing what that really means in terms of how many dollars per year is going to be spent. This is part of the pitch as well. We’re not just managing your investments, because of course sometimes investment management means doing nothing. They hate to suggest that we’re going to be collecting these fees for doing nothing. “Here’s all this other stuff we’re going to do. We’re going to work on your estate planning, we’re going to do your tax planning, we’re going to do these periodic updates, we’re going to review your life insurance,” and all this other stuff. Rarely are they really set up– In fact I’m not aware of anyone who’s really set up to do those things.
Ed: The cutest approach I’ve seen is they’ll make a recommendation maybe half-baked, and then we better see your lawyer. If some say, well we’ll take care of it, get our lawyer. That’s okay, that we got enough work, we don’t need referrals from these folks. They’ll come up with a half-baked idea, and so then we’ll visit with the client and say, “That’s half baked.” Three months later we get this call, “Well I’m getting a second opinion.”
Ed: They’ll shop whoever lawyer tells them, “Yes that approach is great.” Then watch out for perks. If you are getting ball, baseball or football tickets, dinners or special events watch out. That’s a signal that they want to quote personal relationship without regard to investment performance. We had a transaction some years ago involving reviewing the fees cost expenses. This was a situation of a $4 million. Do you recall that Chuck?
Ed: The amount of the fees that they– This is only $4 million. We’ll be talking later today about an estate of $8 million plus let alone– Well, let’s just use the $4 million. What went on there?
Chuck: That was perhaps, one of the most egregious cases that I’ve seen. Where we went through, and we actually analyzed, “Okay are the fees the same as what were really disclosed?” There were several different accounts, and the fees were disclosed as being X percentage of the assets under management. Then when you peel back things a little bit– You realize that well a lot of these investments actually generated their own fees that went straight.
Ed: You had a fee on top of a fee?
Chuck: You had a fee on top of the fee, which was not really in a transparent way ever disclosed to the investor. In this particular instance we had– I think we took a look at– It was like a one year snapshot of what fees were incurred. The advisor had disclosed that he was collecting about $25,000 in fees, and the actual number was closer to 35,000 in fees that–
Chuck: Well yes, plus there’s the soft dollar arrangements–
Ed: That he didn’t disclose.
Chuck: Right yes that are just not disclosed. They always have these side deals with either the investment custodians, or sometimes mutual fund companies, or sometimes there’s a particular investment itself that generates either fees or commissions within the investment. Technically there’s some disclosure form that’s provided but it’s-
Ed: Good luck.
Chuck: -really in small print, but the things that are basically not disclosed at all is that there is also the soft dollar arrangements permeate this entire industry, where there’s a deal with for instance the asset custodian where the asset custodian is not paying cash to the adviser, but creates a fund that that advisor is then able to use to pay for certain types of expenses.
Ed: Marketing, for example.
Chuck: Yes, so that’s just as good as cash. For instance it can pay for software expenses, or continuing education expenses. These are all expenses that the advisor would have to incur anyway. The fact that it’s not being paid in cash is hardly relevant here. It still is effectively the same benefits the advisor as if it had been a cash payment.
Ed: A little bit of a disclaimer here Chuck. I have no problem at all with these percentage charges provided they’re disclosed. The issue that as pervasive is they’re not disclosed, and you ask for the rate of return, and they’re not disclosed.
Chuck: Right, they’re not disclosed. Typically, now there are some exceptions here that I’ve seen, but typically these are not disclosed, and typically they’re buried in the statement. They’re there if you open up your statements, and you look you can even find where the advisor fee is paid, but very, very few of these advisors will– They give you like a quarterly report or something, and very, very few of them will simply just plainly say with their quarterly report, “Okay here’s what your investments did and by the way here’s what my fees were.”
Ed: Right, getting back to the other occurrence. This was not a local guy, this is in Chicago. The disclosed fees were $25,561. This is on a $4 million investment. The actual fees that we came up with, you came up with in addition to that $25,000 were $35,000 more, that is there was a total of $60,000 in fees, but only $25,000 disclosed. They consist of trading costs, mutual fund 12, B1 fees and related charges without regard to whether these assets were readily marketable. Without getting in the question are these investments the best for this individual.
Chuck: Anyway there was a recent article in the Wall Street Journal, published August 9 this year. The caption, “Say goodbye to the 1% investment advisor fee,” a question mark. Yet notwithstanding that embedded within the article is a sentence, “Even as commissions and mutual funds and trading fees have dropped in recent years, the fees that registered investment advisors charge on portfolio balances have edged up. It’s crazy, notwithstanding the disingenuous nature of these fees that is not disclosed, they’re even increasing.
Chuck: That’s incredible because that’s just the opposite of where you would expect the price pressure to be in this space.
Ed: It’s a quasi-monopoly in the sense that the investor assets, manager affairs are all over. The bottom line is if it’s advertised don’t buy it and don’t eat it.
Chuck: We’ve covered this in previous episodes, but the other thing to keep in mind, no matter how much you like your advisor, no matter how good the advisor is at picking investments or somehow contributing to the total performance of the portfolio, that fee is just a direct drag. There’s no way of getting around the mathematical reality that that fee is just directly subtracts from your performance.
Ed: The issue is, when you’re doing well, and the market for the last X number of months has been outrageously high, and so, “Well okay, I made 15% and I was charged to 1.5%. That’s not a big deal, look how much money I made.” When you have a down market–
Chuck: Right, or even a flat market or one that’s not growing very quickly, right?
Chuck: Either one is going to really highlight and illustrate the degree that the fees can drag down an account.
Ed: If you impact inflation, just assume 2%, it may be a negative return with a 1.2% or 1% charge.
Chuck: To put this in perspective, let’s say you have an account where you’re not taking anything out. The purpose of the account is just to grow. The account drops in value because of fluctuations in the market, which this is going to happen to every investor unless they’re just investing in cash, this is going to happen from time to time. Then the market recovers. It recovers by whatever percentage it needs to go up in order to bring investors up to that original level. You will not have recovered, because of the fact that the fees were taken from that account while it was down, and the fees that are taken from the account while it was down are essentially there’s a multiplier effect to that. Those fees have an accelerated ability to prevent the account from recovering fully.
Ed: I think of the example. I have $100,000 and I lose $50,000. To come back to 100, I’ve got to earn 100%.
Chuck: Let’s say that account is an account where you’re getting charged a 1% fee on the investments, and it goes down to $50,000, the fee is still going to come out while the market is down. Typically, what will happen is that there’s very few of these places that will take that fee other than taking a snapshot on the fee date, this is what the account was worth. Then they have a date that the fee actually comes out that may or may not be the actual date that was used for the value snapshot. In other words, you might have an account that’s worth $1 million and they say, “Okay, I’m going to take 1% of $1 million, that’s 10%, but I’m going to take it five days from now.”
Chuck: Five days from now, the account might not be worth $1 million, it might be worth less. The fee then ends up being more than 1%.
Ed: Sure. Let’s think about alternatives. First, a flat annual fee irrespective of the size of the portfolio. I’ve often wondered, why is that a problem? I know of one instance where multiples of $1 million and there’s a flat annual fee of $1 million. What are you talking about? How can that possibly be anywhere near correct? It’s not for me to question that, but the fact of the matter is, you can negotiate a flat annual fee, or you can have a monthly fee based upon time, an hourly charge, but that’s–
Chuck: I’ve had more conversations now than I can count with advisers about what I consider to be the benefit both to the client and I think ultimately to the adviser of charging fees on an hourly basis. I think that would be the ideal method to making sure that you’re delivering something of value, or at least something ascertainable to the client. I’ve not had a single adviser even take a nibble on that.
Ed: Why should you? Look at the money you’re making. If you have a portfolio of $1 million with 8 stocks, say it’s $10 million with the same 8 stocks. Why is there multiple 10 times to manage the larger one when it’s the same activity?
Chuck: I can only assume that, first of all, you must be right about that. Second of all, I think the reason that this is so unpalatable is when they really sit down, they think about, “Okay, what would I have to charge as an hourly rate in order for my income to stay what it is now?”
Ed: We’ll get to that later.
Chuck: They know that the rate would be-
Chuck: -viewed as unreasonable to any client.
Ed: Disclosure. Let’s turn to the Corporate Executive and compensation. I want to make sure we’re directing to the other episodes. That is Episode 16, The Stress-Free Path to Megabucks, The Corporate Executive, and 17, The Stress-Free Path to Megabucks, Not-For-Profit Hospital CEO. I really want to talk about a book by a guy named Steven Clifford. A 2017 book called The CEO Pay Machine. He correctly identifies the distinction between an athlete who’s making gazillions of dollars and a CEO, whether it’s profit or not-for-profit. Aaron Rodgers, Bill Belicheck, Tom Brady make gazillions of dollars, or basketball players, Michael Jordan. That’s capitalism at its finest.
Chuck: You could question whether there’s real value just writ large being delivered by sports in general, but if you accept the fact that sports in general are as valuable as their price–
Ed: I’m not suggesting they’re valuable.
Chuck: It’s very easy to be able to ascertain the individual contribution being made by any of those people, Michael Jordan, you can tell that if the franchise as a whole is worth X, what percentage of X he’s contributing? With the CEO it’s much more slippery.
Ed: Let’s talk about the CEO, whether it’s the for-profit or not-for-profit. Those jocks making megabucks, but if they get hurt, guess what happens? They could be crippled for– That’s not the point. “You want me to go to the play for–? This is the amount of money. You want me to go to Tampa Bay? This is the amount of money. I’m going to leave New England.” The point is, that’s capitalism. Now let’s talk about the CEOs. There they typically make a percentage on invested capital. That wasn’t their money that’s invested. That’s the stockholder’s money, that’s number one. They’re getting, for example, the rate of return, you got $100 million, we’re expecting a rate of return equal to 5%, they’re going to give you X% of the excess. Who sets that? The directors. How does one become a director?
Chuck: The CEO elects you.
Ed: You think the CEO is going to pick you if you ask questions like what compensation? It’s built in, the built-in bias. You pay the director $120,000. I don’t know how much you pay the director with perks and Mr. Director, you’re fantastic. As soon as you’re off the board, you’re garbage. The point is, it’s trumped up, pardon the pun. At the not-for-profit level, we had a debate on this topic with a very well-respected academic on this topic, and I said, “Look, at least, first of all, the officers have a fiduciary and directors have a fiduciary duty to the shareholders to do the right thing.” That gets clouded a little bit, the business judgment rule. In the not-for-profit area, you have the board members. His view was, “The board members, they’re afraid of getting sued.” I said, remember that, Chuck? “What are you talking about?”
Chuck: When was the last time they were sued? That’s what I’d like to know. In the absence of absolute fraud.
Ed: Yes, and they’re not going to be fraudulent. The point is there is no one challenging the compensation of the executive of the not-for-profit. What does that mean? Well, that means that that executive is making a ton of money with no one challenging it. I’m thinking about that as far as some of the amounts and the data that I’ve seen, it just knocks your socks off. By the way, I better not go to any hospital.
Chuck: You’ve probably lost some friends there too.
Ed: That’s okay. Again, they’re coming to the funeral just to make sure that I’m dead. Having said that a sample of some of this what’s going on the amounts are incredible 4 or 5, $10 million to some of these CEOs of these major hospitals that are not for profit. I’m not talking about the for-profit hospitals. That’s understandable. It’s whatever these shareholders and the directors dictate, but in the not-for-profit area, there’s no one on the board that has any skin in the game. Guess what, but let’s not get me too excited about all that. Let’s turn to we beat everyone up on the corporate and not-for-profit side enough Chuck?
Chuck: I think so.
Ed: There are exceptions by the way.
Chuck: We’ll come back. If we feel like we haven’t done enough damage, we’ll come back.
Ed: Again, a disclaimer, that’s not everyone, but when I see in local situations, we have several doctors being compensated in excess of $1 million dollars per year. They’re not practicing. They’re advisors. We have the CEO of 3, 4, $5 million of a not for profit. Who’s on the board? Community leaders. Community leader means you have time to be a community leader. You’re not making money. Let’s talk about executor and trustee fees, and a definition of a fiduciary. What’s going on with that definition? What’s that all about?
Chuck: The word fiduciary gets tossed around an awful lot. Typically it just means, it can mean something extremely broad and very burdensome, or it can mean something fairly light and without any burden at all. For instance, in a certain extent when you have, for instance, an investment account that you’re not using an investment advisor, you’re just trading your own funds. Wherever that custodian is, you could call the custodian a fiduciary in the sense that they do have a duty to maintain proper records, and not lose track of your funds and so on and so forth. They have very, very limited fiduciary duty. When you’re talking about an executor or trustee, when you’re talking about people who are exercising discretion and control, and they are exercising discretion and control over property that is either other people’s property or held exclusively for the benefit of other people. For instance, an executor is administering an estate that is the estate exists for the benefit of beneficiaries of that estate. That’s the highest type of fiduciary duty there is. That particular person is under an obligation to act exclusively in the interest of those beneficiaries, and not in the self-interest of the executor, and not in the interest of even third parties, which might seem, when I say that, like the thing that, well, why would anyone care about third-parties? Well, sometimes that actually does happen where they’re maybe not doing any self-dealing, but they’re worried about some ancillary relationship instead of the beneficiaries of that estate. That’s the highest level of duty that can exist under the law that one person can owe another person. All actions in that capacity need to be directed towards what is beneficial to the beneficiaries of that estate. With really just one exception, and that is that the fiduciary, the executor or the trustee is entitled to be compensated for their services.
Chuck: Fairly. Reasonably.
Ed: Reasonably. Chuck, what’s the role of the lawyer? Is the lawyer a fiduciary?
Chuck: The lawyers are fiduciary, yes.
Ed: In other words, we’ve got to act in the best interest of the client.
Ed: Oftentimes a client will not listen to the advice for whatever reason and guess what we do if that’s the case.
Chuck: Well, it depends on the lawyer, but typically you would disengage.
Ed: That’s exactly right, because people don’t seem to think that lawyers are bad animals. There are some bad animals floating around in the law circles, but those that are really fiduciary has come to realize that you can make a nice living charging an hourly rate that’s reasonable under the circumstances without gouging. I noticed there’s some states, one in particular that the lawyers are acting as trustees. Have you seen that?
Chuck: Well, there’s some states where that is pervasive in the practice of law. I’m not exactly sure if that’s something that occurs just culturally in certain areas, or if there are laws on the books that tend to encourage that kind of thing. There are cities and regions of the country where these law firms have just full-blown trust operations with operations, staff and–
Ed: A percentage charge, of course.
Chuck: A percentage charge, of course.
Ed: The most recent one I saw was this one lawyer, remain nameless, in the website bragged about he was a trustee of about 150 trusts. I couldn’t believe that. How do you have time to have lunch?
Chuck: That’s a person who is really overseeing a staff, and the staff is administrating these 150 trusts. It’s pretty incredible. There’s a few issues, obviously, that arise with that. One is that typically the lawyer is not a close family member. Not somebody who has the same interest that a member of the family would have. Then if the lawyer passes away, or becomes disabled, or retires, or for whatever other reason is unable to continue serving, it’s not like that trust just automatically stays in the law firm. I think most people don’t realize that when they appoint a lawyer to be the trustee, that really is just an individual appointment. If the lawyer is no longer around, or no longer able to perform, there’s really not an institution or an organization that takes over. It’s just like if you appoint your nephew Ted to be the trustee, presumably the other members of the family would know if Ted was starting to lose it, or he got in a car accident or something like that, because they have other connections to him. Here you’re appointing somebody who’s like Ted, just an individual only, you don’t have other connections with that person. Something could come up that makes them unable or inappropriate to perform these duties. You would only discover that by being injured from their failure to administer the trust properly.
Ed: They were friends, they were friends.
Chuck: That’s one of the issues. The other issue is you wonder if the person is really getting proper and independent advice in appointing the lawyer to serve his trust.
Ed: Then when you approach that issue of the beneficiaries was, “Pete’s a friend of mine. Ed, why are you doing this? What’s in it for you?” “Wait a minute. I’m a fiduciary. I’ve got to tell you what’s going on here.” “No, just forget it.” Now let’s talk about my most recent experience about fear and greed at its purest form. We’re talking about an estate. Let’s use an example, of let’s use a $8.5 million. Now the threshold, the required threshold of assets, the gross value must exceed today $11.7 million if Biden’s proposal gets in at $6 million. This particular situation, the individual died, and it was less than $11.7 million, but given the resonance of the decedent, we have to file an Illinois return, and to file the Illinois return, you got a staple to it. The completed version of the federal return. The Illinois return is a couple three pages. It’s a no-brainer. Now let’s go through the math, the arithmetic on this. You have to prepare an estate tax return, which is referred to as a 706. On the return itself, there’s a demonstration number of hours that should be required to complete it. The record-keeping the government suggested is six hours and 46 minutes. I don’t know how they got to that. Preparing the form is 13 hours and eight minutes. Now, this particular asset mix were marketable securities, savings accounts. You get those off the internet, and had an interest in business organizations, had to get the value of the business organization, you can easily get that. Then it had IRAs and life insurance. Now, there’s my dog Jack could probably do this estate tax return. Having said that, guess what the fee quote was on this?
Chuck: I don’t have to guess because I already know. [laughs] They were quoting– Of course, had this fee schedule that I believe if I’m remembering this right. Came to about $180,000.
Ed: About a little over $180,000 which translates to guess what per hour?
Chuck: Actually, I got my calculator out now because I’m calculating that.
Chuck: $6,000 an hour
Ed: $6,000 an hour.
Chuck: What’s wrong with that, Ed? I don’t see the problem.
Ed: Nothing at all. Plus valuation expert fees, attorneys fees, accounting fees, title insurance, recording fees. Without regard to the nature of the asset, this fixed percentage was quoted. Now, if I sound exercised about that it’s because I am. This is pervasive. This isn’t just this client. That’s their published fee schedule.
Chuck: The story gets worse, though. I think it’s worth telling the rest of the story, which is that while the families considered whether to seek a method of having someone else serve. This institution has insinuated that, “We’ll work out some discount,” but they won’t give a quote, which is now there. Before when I said that there’s one exception to the obligation to act exclusively in the best interests of the beneficiaries, and that is that you are entitled to receive a reasonable fee for serving as a fiduciary. There is a transparency requirement with that. You can’t just not tell people what your fees are going to be. It’s just a big no.
Ed: Of course, the client may not be mathematically oriented, and yet, we got a percentage and it’s multiple X dollars of this percent and Y, this percent Z, this percent. The question is, did you tell the client the dollar amount? We’ll give them the percentages. Full disclosure, right? Anyway, that’s what’s going on in the world. Everyone’s migrating to a percentage charge, whether it’s an investment advisor, whether it’s a lawyer. Let’s talk about realtors.
Chuck: Let’s be clear about this. The reason they’re doing that is because it’s a method of making more money.
Ed: What? Are you kidding me?
Chuck: They will never say that, but it’s absolutely a method of making more money. The best example here is the industry that has migrated away from transactional-type fees, that being the investment management, whether you want to call them stockbrokers or investment advisors or financial planners, that constellation of service providers traditionally, decades ago, would almost exclusively make money from transactions. You buy and sell a security, there’s a fee associated with the sale or the purchase itself. That’s how they got paid is on that transaction. That industry has almost entirely moved exclusively over to these asset-based fees.
Ed: When you say almost?
Chuck: There’s a few out. There are still fees systems out there that involve some transaction-related costs.
Ed: By the way, let me interrupt you. Go to that article on The Wall Street Journal. That describes some of those are attorneys.
Chuck: The industry has moved towards an asset-based fee because the industry– I know this, because I was in it.
Ed: Wait a minute, what do you mean by that?
Chuck: I mean I was in charge of a trust department. We crunched those numbers, and we had a brokerage operation. We crunched those numbers, and it was always very clear that this was the path to profitability was to move to these asset-based recurring fees. That is what has driven the decision in this industry, but the sales pitch behind it has been, “Well this way my interests are aligned with yours. If your account goes up–
Ed: We’re in partners. We’re partners.
Chuck: If your account goes up in value, then that’s when I make money. If your account goes down, then I’m suffering with you.” Well, not quite because if the account goes down in value, it’s not like the investment advisor loses money. You the investor loses money. The investment advisor continues to get paid.
Ed: He doesn’t make as much.
Chuck: Just not as much money. It’s a bit of a disingenuous sales pitch that goes.
Ed: Chuck, you’re no longer head of the trust department. Why is that?
Chuck: There’s a lot of reasons. Probably a podcast unto itself. The disclosure to, or the description and the sales pitch to the clients in talking about, “Let’s transition your account over to this type of fee structure,” never says, never includes the statement of, “Oh, by the way, I’ll make more money this way.”
Ed: It’s strange because that’s a fiduciary relationship. It’s upside down. Let’s talk about the realtors for a second here, and the distinction. I view the distinction very, very real in a positive opportunity to discuss the success fee. Brady, Aaron Rodgers are paid on the basis of that success. Now, the 5% or 6% realtor fee, I’ve had that people are criticizing that. As a matter of fact, it’s under the microscope right now. The Justice Department is looking into this. Trump administration had sanctioned the settlement of this, but now the Justice Department is looking into this 5% to 6% commission, and it withdrew. DOJ withdrew from this National Association of Realtors settlement agreement, alleging some anti-competitive practices. I don’t buy that. The realtor is getting paid if there’s a sale, period. How do you contrast that with a corporate executive that’s getting paid no matter what?
Chuck: The investment advisor, right?
Ed: Yes. I’m a big proponent of the realtors. They can be a little difficult. You got to get the sale. You don’t want to do residential real estate transactions for a living, because you have 50,000 phone calls a day. Aside from that, they are being fairly compensated for what they– I’ll defend them in the United States Supreme Court if necessary. Any observations about that?
Chuck: No. It is a success fee and it’s not– I think that’s a good example of the difference between– Just because a fee is expressed in a percentage doesn’t mean that it’s predatory in the way that we’ve been describing here. Most of what we’ve been described in this podcast are fees that are based on a percentage and they recur. Year in year out, that fee gets collected, as opposed to this is a fee on an individual transaction that’s expressed as a percentage of the transaction. This is like a traditional commission. Maybe there are areas of the country where this is not the case. I know around here, there is especially for more expensive properties some competition where the realtors will actually quote different fees if you talk to different realtors, because it makes sense for them.
Ed: They make more money.
Chuck: There’s not an industry-wide collusion involved in setting that at a fixed percentage. There is you could argue for lower-priced real estate. In lower price real estate, you’re also not talking about the impact of the dollar amount being so substantial. If you’re talking about a multimillion-dollar piece of property, then people are competing. That’s where it just becomes a ridiculous fee if you just applied the highest percentage and you didn’t have access to any competition.
Ed: I have a thought on that then. Challenge me on this. It seems to me that whether you’re talking about investment advisory fees, whether you’re talking about lawyer fees, whether you’re talking about realtor fees, there should be a base dollar amount. If you succeed, you’re going to get so much to cover your add-in whatever expenses. They have a sliding scale. You get 3% on the first $100,000, then 4%, and then finally, when you get above what seems to be the market price, you get a big bonus. The individual has an incentive, they get more the investment advisor to get more. I see that same approach with a personal injury lawyer, what’s a third. What do you mean? They’re not going to take the case if it’s a loser. You’d make sure they take it. Let’s talk about if it’s a case, maybe 20% and then you could go up the scale. Again, the personal injury lawyer, the worker’s comp lawyer, it’s based on success. It’s not recurring. I’m not sanctioning a 33% fee, or a 20% fee, I am sanctioning success and measuring.
Chuck: That being a trigger for the fee.
Ed: Yes. If you succeed, investment advisor, this is what I gave you to start with, and at the end of the year, this is what we have, and we’ll decide how the fees are to be split. You get a base amount to cover your expenses, but you get so much per hour, per month, per year, but this flat percentage, irrespective of the size, even though the percentage may decrease is simply inappropriate.
Chuck: Yes. Every place, and I guess I’m not familiar with maybe every single statute where there’s some limitation in place, but in the handful of situations where I know there’s legislation or regulation that imposes a restriction on attorney’s fees, for instance, workers compensation settlement claims, there’s a statutory limitation on how much the attorneys can collect in representing worker’s compensation claimant. The same thing with, for instance, social security disability. Those can be contingent fees, but it’s never 33%, it’s 20%. Maybe there’s some instances where it’s 25, but it’s never as high as 33%, which is interesting. because those are typically lower amounts.
Ed: Yes. Now the other side of this, the lawyers are advertising. The last TV presentation of the six ads, five are from lawyers, and the one–
Chuck: I was going to mention that the last time I went down the rabbit hole of getting into an argument with an investment advisor about, “Why don’t you guys charge hourly fees? It’s just more fair. It’s more transparent, et cetera, et cetera.” The retort that I received is, “Well, our clients complain about the way lawyers charge.”
Ed: That’s right. Yes.
Chuck: I suppose a little humility on our part with respect to all this might be handy, but I do understand there are issues with hourly fees too, especially if they are not applied in a reasonable way.
Ed: Yes, I see the issue in at least our segment of our day jobs is the perception of the absence of value. In other words, how do you measure value, for example, thinking about a recommendation to get the deuce out of the state of Illinois, or change a property from a joint tendency in common and save the resulting tax. The clients simply do not see the value in that, and it’s, “Oh, that’s nothing at all. You’re going to charge for that?” Well, just an example on this question of Illinois versus another state, just recommending a client that they get out of the state of Illinois upon the death of both. If we have a $20 million estate, which is sheltered currently, there’s no state tax.
Chuck: Federal estate tax.
Ed: Federal-state tax. Chuck, you did the numbers. Let me remind you, what the Illinois tax would be.
Chuck: Yes. You’re going to have to remind me because I–
Ed: I will. $1,747,241. The simple recommendation is, get out of the state of Illinois. Guess what? “Oh, you’re charging me for that.” We have the question of what’s the reasonable fee and what is the value? What is the perception? Putting another way, if you thought you’re going to make a gazillion dollars as a licensed professional, guess what? You’re wrong.
Chuck: This touches on an important point, which is that there is a disparity between the actual value and perceived value. The example you just gave is one where there’s the real value behind that advice, substantial value. You could say $1.7 million worth of value behind that advice, but the perceived value is that because it’s a simple recommendation that there’s not much value there. Compare that rewinding to the very beginning of our discussion. We’re talking about these investment advisors, where there is almost uniformly among investors, the sense that the value conferred by the investment advisor is the growth in the account, regardless and with the CEO, there’s the perception that if the company is doing well where the CEO is responsible for that performance, and in both cases that is largely, or at least typically largely a misattribution.
Ed: Now that’s false. Bottom line. That’s false.
Ed: You could say misattribution. That’s nice, but it’s false.
Chuck: Well, it’s just you’ve got the market is going to do certain things, and so you can be a completely random investor, and still you will capture the growth of the market if you’re invested in the market, the investment advisor really has an obligation if they want to demonstrate what value they’re providing, to be able to demonstrate, okay, how much were you capturing in your account that you would not have captured on your own? That’s the real value.
Ed: In excess of the S&P 500.
Chuck: In excess of the S&P 500.
Ed: You get a baseline.
Chuck: Ed, I would even be comfortable if they said in excess of 20% below the S&P 500 because most people who invest on their own, they make mistakes, and they don’t really achieve the same market performance, but in excess of something that’s not zero.
Ed: Well, wait a minute. I’ve got $10 million, I put in the S&P 500 at index and I leave it alone.
Chuck: Yes. That’s you though. Not everybody does that.
Ed: Well, I can make it $100,000, make it $10,000.
Chuck: Yes, but no, no. I’m just saying that most people are unwilling to simply put it in the S&P 500.
Chuck: Well, I don’t know Ed, it seems it’s too easy.
Ed: Yes, it’s not complex enough. This can’t be.
Chuck: They’ve been told their whole life that you have to worry about the risk of investing in stocks.
Ed: Diversification and rebalancing and return, it goes on and on and on, which is frankly crazy.
Chuck: Yes, and whenever I have every single time, I have sat down and actually done the analysis on my own, not looking at their printouts, but just look at the actual growth and the value of an investor’s account, and compared that against the S&P 500.
Ed: The net of fees.
Chuck: Yes, net of fees. There have been– I’ve never run across anybody where they have outperformed on a sustained basis, ever.
Ed: I happen to share that, but I’ve only been doing this 50 years.
Chuck: When you’re planning, if you’re looking at, “Okay, when I’m planning for my future, let’s look at the way the S&P performs. I can expect my account to behave that way.” Well, if that’s what you use to plan, then maybe what you should do when you invest is just invest in the S&P 500 index.
Chuck: Even if it seems too easy.
Ed: Yes because too, this can’t be right. Although I had a client come in the other day, several years ago, his spouse was modest of the financial wizard and the discussion was, and I said, “Ma’am, let’s keep it simple. Put it in the S&P 500 index.” It happened to be with Vanguard. The guy came in just the other day. He said, “My wife thinks that she’s an absolute wizard.” I guess it was five years ago, and she put it in the S&P. Forgot that I told her that, but the point is, she’s a wizard because she invested and she left it alone, and guess what? The management fee was 10, 15 basis points. In other words, nothing, but that’s a good question about, did you forget that I suggested that?
Ed: That’s okay, because the only time I’ve been wrong is when I thought I was. Chuck, again, we got to stay away from dying, because these people will come to the internment, will want to be there to make sure we’re dead, but that’s okay. We’re having fun, and any closing comments that you wish to make?
Chuck: I think we’ve burned enough bridges. I should just stop now.
Ed: Yes, we have burned the bridges, but remember there are exceptions to all these observations. There are good ones and bad ones. There are good lawyers, bad lawyers, realtors. Nothing you can say is an absolute expression. Let’s just say that in general, what we said seems to have some merit.
Chuck: Very true.
Ed: Okay. We’re all done, and next time we’ll have more fun.
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