Paying for advice
What a financial adviser can and can't do for you, how advisers are paid, and what an advice fee costs over time.
FinanceBogle ch. 10About 5 min: 3 reading, 2 practiceUpdated
General education, not financial advice.
- Separate the services advisers can usefully provide from picking market-beating funds
- Explain commission-based and fee-only pay and the conflicts each can create
- Calculate what a yearly advice fee takes over decades
Common-sense investing: the case for index funds: lesson 9 of 13
- Bogle ch. 1
- The Gotrocks family 4 min
- Bogle ch. 2
- Where stock returns come from 5 min
- Bogle ch. 3
- Owning the whole market 4 min
- Bogle ch. 4
- Costs and the market return 3 min
- Bogle ch. 5
- Fund returns versus investor returns 6 min
- Bogle ch. 6
- Taxes are costs too 5 min
- Bogle ch. 7
- When future returns are lower 5 min
- Bogle ch. 8–9
- Why past winners rarely repeat 5 min
- Bogle ch. 10
- Paying for advice 5 min
- Bogle ch. 11–12
- Costs go on forever 5 min
- Bogle ch. 13
- Bonds and money-market funds 4 min
- Bogle ch. 14–15
- New indexes and ETFs 5 min
- Bogle ch. 16–18
- Graham, the arithmetic, and a plan 5 min
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Pairs with Bogle, The Little Book of Common Sense Investing (2007), chapter 10, "Seeking Advice to Select Funds?"
What it is
Bogle separates two things an adviser might do:
- Planning and behaviour: helping you save, set a mix of investments that fits your goals and nerves, think about taxes, plan for a home or retirement, and, perhaps most valuable, stop you making expensive mistakes like chasing hot funds or selling in a panic. Bogle says these services can be worth having.
- Picking funds that beat the market: here he finds no evidence advisers as a group do it. In a study he cites, by a team led by two Harvard Business School professors covering 1996–2002, the weighted return of stock funds held by investors who used advisers was about 2.9% a year, against 6.6% for investors who chose for themselves (excluding up-front charges).
How advisers are paid matters:
- Commission: paid by the product provider when you buy. The adviser may earn more by selling some products than others.
- Fee-only: paid only by you, often starting around 1% of your money a year, according to Bogle. Bogle quotes the adviser William Bernstein: fee-only pay avoids conflicts over which product is sold, though the fee must still be reasonable.
Quick check
Tap an answer to check it.
Which service does Bogle think advisers as a group don't reliably provide?
- He counts this as valuable
- He counts this as valuable
Show answer
Picking funds that will beat the market. He finds no evidence that adviser-picked funds beat the market.
Why it matters
Advice can be worth its price, but only if you know what you're paying and what you're getting. A yearly fee works exactly like a fund's expense ratio: it is taken every year and compounds.
Worked example
100,000 grows for 30 years at 6% a year before the advice fee.
- With no fee: 100,000 × 1.06³⁰ ≈ 574,300.
- With a 1% yearly fee, it grows at about 5%: 100,000 × 1.05³⁰ ≈ 432,200.
The fee takes about 142,200, around 30% of the 474,300 the money would otherwise have gained. Whether that is worth it depends on what the advice saves you: one avoided panic sale in a crash might be worth a great deal.
Common mistake
Treating a recommendation as free. If an adviser is paid by commission, the product price includes their pay; if fee-only, it's on your statement. Either way, ask how much it is in money per year, and what you get for it.
Key terms
- commission
- pay an adviser receives from a product provider for a sale
- fee-only adviser
- an adviser paid only by the client, not by product providers
- conflict of interest
- when an adviser's pay depends on what they recommend
- advice fee
- a yearly charge, often a % of the money advised on
Practise the key terms
Tap a card to turn it over. 4 cards.
| Front | Back |
|---|---|
| commission | pay an adviser receives from a product provider for a sale |
| fee-only adviser | an adviser paid only by the client, not by product providers |
| conflict of interest | when an adviser's pay depends on what they recommend |
| advice fee | a yearly charge, often a % of the money advised on |
Practice
Work it through
50,000 is invested for 20 years at 7% a year before costs. An adviser charges 1.5% a year.
- 50,000 × 1.07²⁰
- 7 − 1.5
- 50,000 × 1.055²⁰
- The difference
Quick quiz
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What is the main conflict with commission-based advice?
- That's fee-only
Show answer
The adviser may earn more by recommending some products than others. Pay depends on the product sold.
According to Bogle, what can make a good adviser worth the fee?
- He finds no evidence for this
Show answer
Planning, and keeping you from costly mistakes such as panic selling. Behaviour and planning, not fund picking.
The other view
Bogle's case is about picking funds, not about advice as a whole. The Harvard researchers Bogle cites also said they remained open to the possibility of "substantial intangible benefits". And Bogle himself says advisers' other services can be valuable.
In short
- Advisers can help with planning, taxes and behaviour.
- Bogle finds no evidence that advisers as a group pick market-beating funds.
- Commission and fee-only pay create different conflicts; both are costs.
- A 1% yearly fee can take around 30% of 30 years' gains.
Mastery check
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Check yourself
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What is a fee-only adviser?
Show answer
One paid only by the client, not by commissions from product providers.
Why does a 1% fee take far more than 1% of your money over 30 years?
Show answer
It is taken every year, and the money taken can no longer compound.
Name one service Bogle thinks can justify an adviser's fee.
Show answer
Any of: financial planning, setting a sensible investment mix, tax help, or keeping you from emotional mistakes.
Further reading
- John C. Bogle, The Little Book of Common Sense Investing (John Wiley & Sons, 2007), chapter 10.
- Bergstresser, D., Chalmers, J. M. R., & Tufano, P. (2009). Assessing the costs and benefits of brokers in the mutual fund industry. Review of Financial Studies, 22(10), 4129–4156.
- Investor.gov, the U.S. SEC's investor site, including how to check an adviser's background (a U.S. example).
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