Don’t hire a financial advisor until you do this

Many advisors and financial institutions would like to manage your 401 (k) account after you terminate your job. Of course, you will be charged for this service, so you have to ask yourself if you will receive good value for the fees you pay.

Many advisors charge a percentage of your assets under management, with a regular 1 percent annual. In general, this charge is added to any investment expenses involved in the investment funds and / or transaction costs of trading individual securities. One percent seems such a small figure; it really can’t make much of a difference, right? Wrong!

Let’s look at an example that shows how much money you’ll pay if you pay a 1 percent rate on your assets.

Suppose you have just retired and have $ 500,000 in your 401 (k) account (often the minimum for many advisors to accept your business). Now, suppose your advisor charges 1% per annum and invests in low-cost mutual funds with commissions of 0.25% per annum (i.e., 25 basis points in investment slang). Your total costs in this situation are 1.25 percent per year, or 125 basis points.

We also assume that you worked for a large employer that offers low-cost mutual funds in their 401 (k) plan and that you could simply have left your accounts with your former employer. In this case, we will assume that your employer’s funds also cost 0.25 percent annually, so your total cost of this option would be 25 basis points.

Even if your 401 (k) plan didn’t offer low-cost funds, you can find funds with comparable or lower costs to companies like Fidelity, Schwab, and Vanguard, which offer index funds with charges around 10 basis points. .

Now let’s make one more hypothesis: that your investments earn 5 percent annually before expenses. Let’s see how much money you have accumulated after 10 years in these two scenarios, assuming you have not made any withdrawals:

• With the investment advisor, your net profit rate is 3.75% per annum (5% minus 1.25%). In that case, after 10 years, your $ 500,000 would be worth $ 722,522.
• If you leave your money in the employer’s plan, your net profit rate would be 4.75 percent (5 percent minus 0.25 percent). In that case, your $ 500,000 would be worth $ 795,262 in 10 years. That’s $ 72,740 more compared to working with your investment advisor.

Financial advisers you can quickly point out that this example is unfair because they can add value by increasing your rate of return if you invest with them. The problem with this argument is that a lot of evidence shows that most active managers do not exceed their benchmarks over time. Therefore, it is really difficult to state that they can surpass a low cost index fund in the 401 (k) plan of a large entrepreneur after all the costs have been considered.

But financial advisors can add value in other ways. For example, they can help you determine the right amount of risk to take on your investments, they can help you reduce the taxes you pay, they can help you reduce debt, help you with your budget, work with you. to select retirement income. strategy and be there to calm your fears when markets are melting. These are just a few examples, there are many more.

But could you buy this help for less than $ 70,000 over 10 years? And do you have to pay them every year for these services?

Suppose you hire a financial advisor who charges $ 300 per hour (probably at the higher end of rates). We also assume that you need to spend 10 hours a year with him to review your situation. You would pay $ 3,000 a year or $ 30,000 for 10 years.

To accumulate $ 70,000 in charges for 10 years, you would have to consume 233 hours of your time, which is not likely unless you have a very complex situation, in which case you may receive good value for that money.

The math in the example above gets worse if:

• your advisor charges more than 100 basis points
• your advisor uses funds that charge more than 25 basis points
• you are invested for more than 10 years
• you have over $ 500,000 in savings
• you’re lucky enough to participate in a 401 (k) plan that charges less than 25 basis points, or smart enough to find those funds on your own.

Here’s just one example of the last point: The federal savings plan (TSP) for government employees offers investments with average costs of 2.9 basis points. For most government workers, it would make no sense to transfer money out of the TSP – it’s one of the best deals.

On the other hand, I’ve seen 401 (k) plans from smaller employers that include charges of 150 basis points or more. In that case, for most people it would be crazy to leave their money in the plan.

Even if you have well under $ 500,000 in savings, you can still save thousands of dollars by reducing the commissions you pay for your investments. In the example above, if you had $ 100,000 savings instead of $ 500,000, you could save $ 14,548 over 10 years by paying 25 basis points instead of 125 basis points.

So what can you do if you decide to keep your money in your employer’s plan but also need financial advice? You have a few options.

You can find financial advisors who charge by the hour, such as those who work with Garrett Planning Network. In addition, many 401 (k) plans now offer professional advice through services such as financial engines, usually at costs that are half those of retail advisors.

The bottom line is that a few percentage points of spending can make a big difference over time. Before deciding what to do with your money, you’ll want to determine the costs of your 401 (k) plan funds and compare them to the costs of any financial advisor or institution you plan to invest with. It shouldn’t be that hard to do because all 401 (k) plans are now required to disclose their fund rates.

It is common sense in America to ask yourself how much you will pay for the services you provide and make sure you get the best value for your hard earned dollars.