Wealth Managers: A Plague on Investors

Wealth Managers: A Plague on Investors

By David M. Simon

Investors should avoid wealth managers like the plague. Wealth managers enrich themselves at investors’ expense. Wealth managers charge exorbitant fees and push clients to invest in actively managed funds and hedge funds that produce lower returns than low or no-fee index funds.

Most wealth managers charge about one percent of the money that they manage. Over 20 years, a Securities Exchange Commission bulletin shows that a one percent fee reduces a $100,000 investment that earns four percent per year before fees by over $38,000.

To compound the harm that they do to investors, wealth managers push their clients to invest in actively managed funds with impressive sounding names that supposedly will outperform index funds.

But actively managed funds charge investors much higher fees than index funds and fail to perform as well.

The Investment Company Institute reported that at the end of 2017, the average actively managed equity fund charged investors 0.78 percent of the sum invested, while the average actively managed bond fund charged 0.55 percent. Index funds charge much less: 0.09 percent for the average equity index fund; 0.07 percent for the average bond index fund. And some of the biggest index funds charge even less. The Vanguard Group has an S&P 500 index fund that charges 0.04 percent. Fidelity Investments has a similar index fund that charges no fees.

Over 20 years, the same Securities Exchange Commission bulletin shows that a 0.50 percent higher fee reduces a $100,000 investment that earns four percent per year before fees by over $20,000, and a 0.75 percent higher fee reduces the same investment by almost $30,000.

And these high fund fees are on top of the wealth manager’s fee. Together, the two sets of fees leave the same investor with over $63,000 less than had the investor independently put the money in a no-fee equity index fund (and with almost $55,000 less than in a no-fee bond index fund).

The combination of exorbitant wealth management and actively managed fund fees make the performance of the actively managed funds all the more important. Yet they rarely perform as well as index funds.

Over the 15-year period ending on June 30, 2018, 92.43% of large-cap funds, 95.13% of mid-cap funds, and 97.70% of small-cap funds failed to perform as well as the benchmark indices in these categories, S&P Dow Jones Indices reported. Most actively managed bond funds also failed to perform as well as their benchmark indices. For long-term U.S. government bond funds, 98.08 percent failed to perform as well as their benchmark index.

Wealth managers also push investment in hedge funds – an even worse choice. Economist Mark Perry reported in Seeking Alpha that while $100,000 invested in an index fund tracking the S&P 500 on January 1, 2008, would have grown to $225,586 on December 31, 2017, the same sum invested in the average hedge fund would have grown to only $148,000 – over $77,000 less.

And then there are the stratospheric hedge fund fees. Institutional Investor reported in June 2018 that the average hedge fund charges 1.5% of the invested sum, plus 17% of the fund’s return. These fees reduce the one-year return on a $100,000 investment that earns four percent before fees from $4,000 to about $1,820.

Add this doesn’t include the one percent wealth manager’s fee. It further reduces the $4,000 gain to about $800.

Meanwhile, the same investment in a zero-fee index fund leaves the investor with the full $4,000 gain.

The lessons for investors are simple and clear. Avoid wealth managers. Invest in index funds.

No wonder legendary investor Warren Buffett recommends to investors that they invest 10% in short-term government bonds and 90% in very low-fee S&P 500 index funds and avoid wealth managers: “I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”

David M. Simon is a lawyer in Chicago. The views expressed in this article are his own and not those of the law firm with which he is affiliated. For more, please see www.dmswritings.com.