What physicians should consider when hiring a financial planner or asset manager

In 2010, a former postal worker, Jimmy McMillan, famously ran for Governor of New York on the slogan, “The rent is too damn high!” That slogan can also be applied to the price most physicians are paying for financial advice. When it comes to investing, unlike with most things in life, you get (to keep) what you don’t pay for. Advisory and management fees come directly out of your investment return. Therefore, your goal should be to pay the least amount possible for good financial planning advice and quality asset management.

Jack Bogle, the founder of Vanguard, has said, “The long-term investor must be aware of the portion of investment return that will be consumed by [investment] expenses. Cost lops the same number of percentage points off both nominal and real [after-inflation] returns, but given persistent inflation, it nearly always consumes a proportionally larger share of real returns. To state the obvious, the long-term investor who pays the least has the greatest opportunity to earn most of the real return provided by the stock market.”

Consider two investors who each contribute $50,000 in the same investment, which returns 9 percent per year—before expenses—over 30 years. The first pays 0.1 percent in annual expenses. The second pays 2 percent in annual expenses. After 30 years, the first has $6 million. The second ends up with $4.2 million—30 percent less. Bogle refers to this phenomenon as the “tyranny of compounding.” Just like the “magic of compounding,” where small differences in return can result in a vast difference in wealth over many years, with the tyranny of compounding, small differences in expenses can also result in a monstrous loss of wealth.

Another way to demonstrate the importance of keeping investment costs low is to consider your portfolio withdrawals in retirement. Historical studies demonstrate that investors can take out around 4 percent of their portfolio value per year and expect it to have a very good chance of lasting at least 30 years. If investors are paying 2 percent in investment expenses, then they can really only withdraw 2 percent per year and expect the portfolio to last. If you combine the smaller portfolio value from the above example with a lower withdrawal rate in retirement, you’ll see that high-cost investors end up being only able to spend 35 percent as much in retirement as low-cost investors, or $84,000 versus $240,000.