Investment fees: How much is too much?

By Walter Updegrave, senior editor

(Money Magazine) -- Question: My $500,000 portfolio is managed by an adviser who sets my asset allocation and then invests in well-diversified low-cost index funds. He charges me $1,000 a year to manage the portfolio, plus another $700 annually to rebalance. Do you think this adviser is too expensive? Would I be better off managing the portfolio on my own, assuming I continue to invest for the long-term mostly in low-cost index funds and ETFs? -- Brian C., Texas

Answer: Before we get to the issue of whether you're better off sticking with your adviser or flying solo, I have to tell you that this arrangement of paying separately for rebalancing is new to me.

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

Since setting your asset allocation policy is one of the services your adviser is providing -- indeed, you could argue that since you're in index funds it's the most important service he's providing -- I would have thought that rebalancing, or periodically restoring your portfolio to the appropriate asset mix, would be a normal part of his investment management process.

I could understand separate charges for rebalancing to cover transaction costs and such, if there are any. And I suppose I could even see a rebalancing fee if the adviser used some fancy rebalancing method that required additional time and attention on his part.

But seven hundred bucks a year? That's almost as much as the regular management fee. Besides, many 401(k)s offer an automatic rebalancing option for no charge, so it's hard for me to imagine why you're paying so much for it.

So if nothing else, you want to ask your adviser why you're being charged this amount and exactly what you're getting for it.

That said, assuming there are no other fees you haven't mentioned, I have to tell you that, even after combining the $1,000 management fee and the $700 rebalancing levy, what you're paying in total to your adviser to create and oversee a portfolio of index funds strikes me as pretty fair in the grand scheme of things.

Basically, you're paying 0.34% of assets ($1,700 divided by $500,000) per year for investment management. Throw in the annual expenses for the index funds -- which, if they're truly low-cost like you say should run less than 0.50% annually and might even come in at 0.10% or less -- and I would expect that you're paying well below 1% a year, perhaps even less than 0.50%, depending on the funds your adviser uses. (Which, by the way, is another issue to discuss with your adviser: What are your costs all in?)

By comparison, it's not unusual to see some advisers charging 1% to 2% a year to manage a portfolio the size of yours, and that's on top of the underlying fund fees, which, in the case of actively managed funds, can easily add another 1% or more to your annual tab.

So assuming you're getting a reasonable package of services -- the adviser actually discussed your needs when creating your asset allocation as opposed to just willy nilly assigning you to a mix based on your age and you get quarterly reports showing how your funds and portfolio are doing compared with appropriate benchmarks -- then on the face of it I'd say what you're paying sounds reasonable. By the standards of the investing world -- which, granted, isn't a very high bar -- it may even be a bargain. The real way to tell, of course, is to shop your portfolio around and see what other advisers will charge.

As to whether you should fire your manager and invest on your own, the main issue is how confident you feel about handling that five hundred grand on your own.

On the one hand, you could pretty easily just continue following the strategy your adviser has already set for you. You could simply adhere to the asset allocation your adviser has set, stick with the same or similar index funds and rebalance on your own each year.

And that piggyback strategy may very well work for a while. But inevitably you're going to have to make decisions on your own. You may be tempted to change your asset allocation, perhaps to respond to changing market conditions. Is that really a good idea, or would doing that be venturing into the murky waters of market timing? At some point, you'll also probably want to re-evaluate your asset mix just because you've aged and may want more principal protection and less growth. Are you comfortable making that shift on your own?

I also notice that you say you want to invest "mostly" in low-cost index funds and ETFs. Does that mean you're re-thinking your adviser's all-index strategy? I'm not a purist who says your portfolio has to be 100% indexed. B

But I'm also realistic enough to know that picking good actively managed funds, while not impossible, isn't a cakewalk either. (I can tell you that a lot of time, thought and effort go into picking the funds that make up our MONEY 70 list of recommended funds.) And the last thing you want to do is fall into the trap of chasing funds that have soared lately.

Bottom line: Before you do anything, I think you need to assess your investing abilities. Be honest. Do you really understand how to set your own asset allocation?

Are you aware of both the short- and long-term consequences of different mixes of stocks and bonds? (You can see how portfolios ranging from very conservative to highly aggressive might fare by going to Morningstar's Asset Allocator tool.)

And do you have the resolve to stick to your allocation, even when pundits are saying it's time jump out of stocks and into bonds (or vice versa?) or move your money into emerging markets, gold, silver, corn or whatever other area is hot at the moment?

If, after evaluating your abilities, you decide you're confident about going out on your own, fine. Go for it. I'm all for people taking charge of their finances, provided they're serious about it and know what they're doing. But remember: if you overestimate your abilities and end up making a hash of your portfolio, you could end up costing yourself a lot more than $1,700 a year. To top of page

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