So, no one likes to pay fees, right?
For the growing number of investors that do pay an advisor fees for investment management, they typically do so because they recognize that they’re most likely not the best person for the job—the job of managing their investments, that is.
But there could be an upside to an investment advisor costing you more money than the alternative of DIY’ing it at Vanguard.
Aside from the obvious benefits that 2008 and other volatile markets bring to the table in terms of benefits of having someone else — your advisor —at the helm, there are several benefits that investors rarely take advantage of when it comes to paying investment management fees.
While investment management fees are not always tax deductible, it’s worth taking a deeper look.
If you itemize deductions each year, this is the first step towards your fees being deductible. Then, you have to subtract 2% of your Adjusted Gross Income (AGI) from the total, to arrive at the amount you can deduct.
The IRS considers investment management fees as expenses for the management of property held for the production of income and allows you to deduct them as a miscellaneous itemized deduction along with other miscellaneous itemized deductions including tax preparation fees. You report your miscellaneous itemized deductions on Schedule A of your tax return and then you reduce them by subtracting 2% of your Adjusted Gross Income.
If you are subject to Alternative Minimum Tax (AMT), your fees may not be deductible and, honestly, this means you should be using a CPA to file annually. Simply make sure your tax professional has the fees along with all of your other deductions and let them do the heavy lifting on the amount you can deduct.
Here’s an example: Assume your investment advisory fees were $8,000 and your tax preparation fee was $1,500. Also assume that your AGI was $100,000. Your total miscellaneous itemized deductions of $9,500 will be reduced by $2,000 (2% of $100,000) leaving a deduction of $7,500.
Safety in a Fiduciary
Again, while there are always exceptions to every rule, if you’re paying investment advisory or management fees, your advisor is most likely acting as a fiduciary.
Big word, right? Fiduciary…
Having an advisor that is a Fiduciary is the ONLY type of advisor to be paying. Period.
Why’s that? A fiduciary advisor is governed in a much stricter way than that of, say, an advisor who is not acting as a fiduciary. This equals more protection for you and more assurances that your advisor will be more likely to be acting in your best interest. This is a biggie.
An investment advisor acting as a fiduciary will have asked you to sign a contract. This is step one in knowing if your advisor is acting in a fiduciary capacity. Take it to the next level – ask your advisor as well as take a look at their U4, which is easily accessible with the FINRA Broker Check Tool. This ensures you have a FIDUCIARY working for you.
The first page of the Broker Check tool shows you right away whether you’re working with a licensed Investment Advisor (see my U4 as an example).
Again, even though the advisor is a licensed Investment Advisor, you haven’t necessarily engaged with them as such.
If they’re acting as a fiduciary, with you as a client, you must have a signed contract with them. Ask for a copy of your contract, and take the opportunity to review your fees, which should be disclosed in the contract terms.
Fees are negotiable
That’s right, negotiable.
Not all advisors may be willing to negotiate, but why not give it a shot?
Take inventory of the goods and services that you spend money on year in and year out:
- Do you shop around for the best deal, and ask for discounts? Of course you do!
- Do you pay full price for the car on the lot? Of course you don’t!
Simply ask your advisor if they offer discounts and/or how your fee could be lowered now or in the future. Find out how competitive their fees are and do some comparison-shopping before you go in for “the ask”.
IF you’re with the right advisor, advisory fees are worth it. And while they can certainly add up over the years, make sure you do your best to keep them as low as possible, without alienating or offending your advisor. If approached the right way and with adequate research as to the competition’s fees, your advisor will be glad you asked and think better of you for it.
Investor Bad Behavior
This blog is, after all, intended to save you money, so it wouldn’t be complete if it didn’t touch on the cost of NOT hiring an advisor…
Look no further than to DALBAR’s annual study of Investor Bad Behavior and how prevalent and costly investment errors are when investors who truly don’t have the skills or inclination to manage investments effectively don’t hire an advisor.
In 2013, DALBAR calculated the average cost of bad behavior (poor timing, buy/sell decisions) was close to 7% for broad equity investors – that’s 7 times what an effective advisor should cost you each year, or 1%!
If you don’t have the skills or the passionate desire to manage your investment portfolio, it might be time to hire an advisor. But above all, make sure you negotiate, hire a fiduciary (check their U4) and deduct your fees.