Financial Advisor or Stockbroker. A Brief History.

In a recent interview, I was asked whether the 30 basis points charged against Mac McAllister’s $18,900,000 account in Deadly Portfolio: A Killing in Hedge Funds was realistic. 30 basis points is three-tenths of a percent, or $56,700 each year for managing the account.

An $18,900,000 account is not 18.9 times more work to manage than a $1,000,000 account. Brokers know this. Larger accounts get the larger discount. Advisors don’t want to be undercut on fees, and the competition is vigorous.

Financial advisors want more than 30 basis points across their entire book of business, however. Otherwise $100,000,000 under management would only generate $300,000 in gross revenue. They compensate for the low rate offered larger investors by charging a higher percentage against the total value of the assets in smaller accounts. A $500,000 account would probably be on the books at a rate of 70, perhaps even 80, basis points—generating in other words $3,500 in income for the advisor.

Financial advisors look to accomplish two things; namely, 1) increase the income across their entire book of business and 2) decrease the amount of time that it takes to generate it.

When I entered the business in 1992, advisors were still expected to manage the portfolios for their clients. They picked the stocks, bonds, mutual funds, and other holdings based on their own research.  Holdings were selected keeping each client’s investment personality in mind. As clients were added, this began adding up to one hell of a workload.

Time became an adviser’s most precious commodity. Growing the business meant acquiring more clients. More clients meant more review meetings to schedule, more portfolios of track, more trades to solicit to keep pace with changing market conditions. A critical point was reached where the adviser’s time was taxed to the limit. 60 hours a week did not get the job done. Taking on additional clients meant that less time could be devoted to those already on the books.

Less than 20% of those entering the profession survive the first five years. For those who make it, however, survival going forward depends on several variables. The financial advisor can concentrate only on larger clients and drop those that were enlisted in the desperate months of trying to make quota for the company.

Or the financial advisor can delegate the investment management role to somebody else. The adviser no longer picks individual securities for the client. An institutional money manager takes over. For larger accounts of $250,000 or more, advisers hook up with huge pension fund managers who let the client to ride along for a fee. A manager may mean more cost to the client and less income for the adviser, but superior returns and less work are the payoffs respectively for the parties.

Smaller accounts, those under $250,000, are better off in mutual funds for the diversification that they provide, but here again, the adviser can delegate the job of picking the funds and keeping the balances in the portfolio responsive to changing market and economic conditions. The same tradeoffs apply—better returns for the client; more time for the advisor.

Delegating that task on both larger and smaller accounts has caused a shift in the role of the advisor. Financial planning has taken over. The advisor is taking the longer look and helping the client prepare for retirement, expanding a business, or inheritance for survivors. It is a very important role and one that was often ignored a couple of decades ago. The credentials are different. The profession has changed.

The smaller investor comes out the winner by not getting lost in the advisor’s book—a small fish in a big pond. Instead he or she benefits from the same considered and timely moves as the largest account on the books. The additional expense may be a consideration. Fees may run as high a 1.50% in addition to the costs imposed by mutual fund companies.

An investor should be willing to pay 1.00% more in fees to enjoy a 3.00% higher return. Unless an investor can run two parallel accounts; one with an institutional money manager and one being run as the investor or directs, it will always be impossible to say with certainty whether the additional charge was worth it. For my money, however, it always is.